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MASTER’S THESIS

VALUATION OF TESLA MOTORS, INC.

COPENHAGEN BUSINESS SCHOOL, 2016

MSC ACCOUNTING, STRATEGY & CONTROL

NUMBER OF PAGES: 80

NUMBER OF CHARACTERS: 173,480

DATE OF SUBMISSION: MAY 30TH 2016

AUTHOR: NORBERT KÁIN

CPR NUMBER: 090391-XXXX

SUPERVISOR: OLE VAGN SØRENSEN

SIGNATURE:

Master’s Thesis 2016 Norbert Káin Cand. Merc. ASC

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TABLE OF CONTENTS Chapter 1 – Problem formulation ....................................................................................................................................... 4

1.1 Introduction............................................................................................................................................................... 4

1.2 Problem statement .................................................................................................................................................... 6

1.2.1 Sub-questions ..................................................................................................................................................... 6

1.3 Delimitation .............................................................................................................................................................. 7

1.4 Methodology and Theory of Science ........................................................................................................................ 7

1.4.1 Assumptions about the Nature of Social Science .............................................................................................. 8

1.4.2 Assumptions about the Nature of Society ........................................................................................................ 11

1.4.3 The chosen paradigm ....................................................................................................................................... 15

1.4.4 Research Design .............................................................................................................................................. 17

1.4.5 Strategic analysis ............................................................................................................................................. 18

1.4.6 Financial analysis ............................................................................................................................................. 19

1.4.7 Forecasting ....................................................................................................................................................... 20

1.4.8 Valuation.......................................................................................................................................................... 20

1.4.9 Data collection ................................................................................................................................................. 20

Chapter 2 – Tesla Motors & Automotive Industry ........................................................................................................... 21

2.1 Tesla Motors ........................................................................................................................................................... 21

2.1.1 Three-step master plan ..................................................................................................................................... 21

2.1.2 Vehicles and Energy storage applications ....................................................................................................... 22

2.1.3 Historical events & Share price development .................................................................................................. 24

2.2 The Automotive Industry ........................................................................................................................................ 26

2.2.1 The Electric Vehicle Market ............................................................................................................................ 29

Chapter 3 – Strategic Analysis .......................................................................................................................................... 31

3.1 External analysis: PEST analysis ............................................................................................................................ 31

3.1.1 Political factors ................................................................................................................................................ 31

3.1.2 Economic factors ............................................................................................................................................. 37

3.1.3 Social factors ................................................................................................................................................... 43

3.1.4 Technological factors ....................................................................................................................................... 44

3.1.5 Conclusion of external analysis ....................................................................................................................... 45

3.2 Industry analysis: Porter’s five forces analysis ....................................................................................................... 47

3.2.1 Threat of new entrants ..................................................................................................................................... 47

3.2.2 Threat of substitutes ......................................................................................................................................... 49

3.2.3 Bargaining power of suppliers ......................................................................................................................... 50


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3.2.4 Bargaining power of customers ....................................................................................................................... 52

3.2.5 Intensity of existing rivalry .............................................................................................................................. 53

3.2.6 Comperative industry structure analysis .......................................................................................................... 54

3.3 Internal analysis: Value chain analysis & VRIO .................................................................................................... 55

3.3.1 Support activities ............................................................................................................................................. 56

3.3.2 Primary activities ............................................................................................................................................. 59

3.3.3 VRIO ............................................................................................................................................................... 62

3.4 SWOT analysis ....................................................................................................................................................... 63

3.4.1 Strengths .......................................................................................................................................................... 64

3.4.2 Weaknesses ...................................................................................................................................................... 65

3.4.3 Opportunities ................................................................................................................................................... 66

3.4.4 Threats ............................................................................................................................................................. 67

Chapter 4 – Financial Statement Analysis ........................................................................................................................ 68

4.1 Analysis of accounting policies .............................................................................................................................. 68

4.1.1 Changes in revenue and cost allocation ........................................................................................................... 68

4.1.2 Changes in balance sheet items ........................................................................................................................ 69

4.2 Reformulation of the income statement and balance sheet ..................................................................................... 69

4.2.1 Analytical income statement ............................................................................................................................ 70

4.2.2 Analytical balance sheet .................................................................................................................................. 70

4.3 Financial analysis .................................................................................................................................................... 71

4.3.1 Operating efficiency ........................................................................................................................................ 72

4.3.2 Asset use efficiency ......................................................................................................................................... 73

4.3.3 Liquidity risk ................................................................................................................................................... 73

Chapter 5 – Forecasting .................................................................................................................................................... 76

Chapter 6 – Valuation ....................................................................................................................................................... 78

6.1 The discounted cash flow approach ........................................................................................................................ 79

6.2 The economic value added approach ..................................................................................................................... 80

Chapter 7 – Sensitivity Analysis ....................................................................................................................................... 81

Chapter 8 – Conclusion .................................................................................................................................................... 82

Bibliography ..................................................................................................................................................................... 84

Appendix .......................................................................................................................................................................... 93


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CHAPTER 1 – PROBLEM FORMULATION

1.1 INTRODUCTION

The aim of this thesis is to conduct an independent valuation of the American electric vehicle and

energy storage manufacturer, Tesla Motors, Inc. (TSLA).

The automotive industry is highly cyclical, meaning that it performs well when the economy is in

booming period and suffers when the economy is in recession. Investors in cyclical industries,

therefore, want to know where the bottom and the top of the business cycle are in order to buy and

sell these stocks at the optimal time. One goal of this thesis is to help these investors by analysing

macro and industry factors with a special focus on alternative fuel segment due to the company’s

positioning. The segment in which Tesla is operating in has some unique features compared to

traditional automobile segment. Electric vehicles, unlike traditional cars equipped with internal

combustion engines, take advantage of high oil prices but rather sensitive to political and

technological changes in terms of government regulations and innovations that can affect price and

attractiveness of these products.

Source: Compiled by author / NASDAQ

0,00

50,00

100,00

150,00

200,00

250,00

300,00Share price development, USD

Tesla General Motors Ford Toyota Motors Honda Motors

2011 2012 2013 2014 2015 2016


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The automotive industry is under even more pressure than ever due to economic austerity and

increasing environmental concerns. Manufacturers constantly have to innovate due to intensified

competition and new regulatory compliances setting higher fuel-efficiency standards.1 According to

Nieuwenhuis, there is an inevitable trend for automobiles to shift towards electric powertrains,

making them over time less of mechanical and more of electronic devices.2 This trend can be well-

observed from the above figure, which shows that Tesla Motors with its long-distance electric

vehicles has significantly higher stock value increase than the biggest players representing the

traditional segment of the industry. The fact that Tesla, who was founded a bit more than a decade

ago and could report GAAP-based profit in only one quarter since its operation, could manage to

reach around half of the market capital of some of the well-established automakers with hundred

year’s history, makes the company an interesting subject of analysis.

Moreover, the current dissension among industry experts about the fair value of one Tesla share

makes the analysis more desirable. As of 23 May 2016, FBR & Co. had the lowest price target of

USD 150, while Dougherty & Co. had the highest estimate of USD 500. Opinions of well-known

rating companies differ on the appropriate stock price as well. Bank of America and JPMorgan Chase

& Co. have one of the lowest estimates of USD 155 and USD 185, although JPMorgan Chase & Co.

has increased its target from USD 170. Goldman Sachs and Morgan Stanley have a lot higher price

target of USD 250 and USD 333. As a result, Tesla Motors Inc. has a consensus rating of “Hold” and

an average price target of USD 278.41. From the biggest financial companies, six have rated the stock

with a selling rate, four have assigned a hold rating and thirteen have given a buy rating to the

company’s shares with one strong buy rate.3 I find it extremely interesting how different, well-known

financial companies have distinct opinion about the right stock value of Tesla Motors Inc. This is

where I find my choice of topic and independent analysis relevant and useful for current and future

investors.

1 Boston Consulting Group (2014), ”Accelerating Innovation: New Challenges for Automakers”, p. 5 2 Nieuwenhuis, P. Wells, P. (2012), “New Business Models for Alternative Fuel and Alternative Powertrain vehicles”, p. 56 3 MarketBeat (23.05.2016), “Tesla Motors Company Profile (NASDAQ:TSLA)”


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1.2 PROBLEM STATEMENT

What is the fair value of one Tesla Motors (TSLA) share as of 23.05.2016?

1.2.1 SUB-QUESTIONS

In order to answer the problem statement, a thorough strategic and financial analysis will be

accomplished. The following sub-questions will be answered to support findings:

Chapter 2 – Tesla Motors & Automotive Industry

- What business model and strategy does Tesla Motors follow?

- What are the characteristics of the automotive industry and the electric vehicle

segment in particular?

Chapter 3 – Strategic Analysis

- Which macro-economic factors influence Tesla’s risk and future cash flow potential?

- What is the overall attractiveness of the industry and how does it affect Tesla’s

operations?

- What are the core capabilities of the company?

- Does Tesla possess a competitive advantage and is it sustainable?

Chapter 4 – Financial Statement Analysis

- Was there any change in the firm’s accounting policies?

- What is the historical profitability and liquidity risk of the company?

- What are the prospects for future financial performance?

Chapter 5 – Forecasting

- How will the expected market outlook affect Tesla’s key value drivers?

- What is Tesla’s future profitability potential?

Chapter 6 – Valuation

- What is the appropriate discount rate?

- What is the present value of future free cash flows to firm and economic value added?

Chapter 7 – Sensitivity Analysis

- How sensitive is the valuation to changes in the key value drivers?


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1.3 DELIMITATION

The paper is written from an independent analyst’s perspective who has no more – internal –

knowledge than the market and no access to primary data. If internal information is available, a

more refined analysis can be developed. Due to the dynamic nature of Tesla’s external factors,

assumptions are based on information available until 23 May 2016. Therefore, an analysis of Tesla

Motors Inc. conducted after this date might lead to a different result.

1.4 METHODOLOGY AND THEORY OF SCIENCE

Within the methodology section I present the research design of the project. The aim of this chapter

is to discuss how the project is structured in a logical way that allows the reader to see the connections

between the research issues that have been showed in the ‘Problem statement’ section, the

philosophical assumptions underlying the approach of the project, the theories have been used, the

way in which data have been collected and analysed, and the result of this thesis. Therefore, we can

declare that research design is the ‘blueprint’ or the ‘master plan’ of the project. In terms of

Philosophy of Science, the understanding of these connections gives the paradigmatic grounding of

the research which has a strong influence on the methodology of the project. As methodology is the

backbone of the project, I put a great emphasize on finding the right methodological approach thus

the project reflects the work of Gibson Burrell and Garth Morgan who have developed a framework

for conducting research.

According to Gibson Burrell and Garth Morgan, “Social science can usefully be conceived in terms

of four key paradigms based upon different sets of meta-theoretical assumptions about the nature of

social science and the nature of society”. (Burrell and Morgan 1979, p. viii) These four paradigms

are Functionalist paradigm, Interpretive paradigm, Radical Humanist paradigm and Radical

Structuralist paradigm. Each of the paradigms determined by the four sets of philosophical

assumptions related to ontology, epistemology, human nature and methodology, in accordance with

two sets of dimensions. The dimensions of which Burrell and Morgan distinguishes are the

‘Subjective-Objective dimension’ and the ‘Regulation-Radical change dimension’. While the former

focuses on how knowledge about social reality is created, the latter is concerned with the nature of

human society.


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1.4.1 ASSUMPTIONS ABOUT THE NATURE OF SOCIAL SCIENCE

Burrell and Morgan state that “All Social Scientists approach their subject via explicit or implicit

assumptions about the nature of the social world and the way in which it may be investigated.”

(Burrell and Morgan 1979, p. 1) As it was mentioned above, these assumptions are related to:

Ontology: describes the essence of phenomena under investigation.

- Assumptions: Whether the reality to be investigated is external to the individual or the

product of individual consciousness? Whether reality is given out there in the world

or the product of one’s mind?

Epistemology: describes how one understands the world and communicate it as knowledge to

others.

- Assumptions: What forms of knowledge can be obtained, and how can one sort out

what is to be regarded as ’true’ from what is to be regarded as ’false’? Whether

knowledge can be acquired or it has to be personally experienced?

Human nature: describes the relationship between humans and their environment.

- Assumptions: Are humans determined by their environment or do they have a ’free

will’, where man is regarded as the creator of his environment?

All three sets of assumptions directly affect the nature of methodology. On the basis of either

objectivistic or subjectivist approach to social science we should distinguish between different

ontology, epistemology and model of human nature which lead to different methodologies.

Objectivists see the social world as it if were hard, external and objective reality. They examine

relationships and regularities between the elements and search for concepts and universal laws to

explain reality. Subjectivists focus on how individuals create, modify, and interpret the world, and

see things as more relativistic. These two approaches to social science lead to four main socio-

philosophical debates, which will be further discussed below. The following figure represents the

‘Subjective-Objective dimension’ which shows the outcomes of both subjectivist and objectivist

approach to social science.


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Subjective-Objective dimension

The subjectivist approach to

social science

The objectivist approach to

social science

Nominalism Ontology Realism

Anti-positivism Epistemology Positivism

Voluntarism Human nature Determinism

Ideographic Methodology Nomothetic

1.4 .1 .1 SO CIO-PHILOS O PHICAL DEBATE S

The above figure outlines the different ontological, epistemological, human and methodological

standpoints which characterise either subjectivist or objectivist approach to social science. These two

approaches are opposite of each other hence creating socio-philosophical debates related to the four

sets of assumptions. In this section of the methodological chapter these four debates will be reviewed,

first examining the subjective and then the objective approach, in order to find the dimension which

is best suited for the problem.

1.4 .1 .1 .1 THE ON TO LO G I CAL DEB AT E : N OM IN A LIS M -RE ALIS M

Nominalism has the view that “the social world external to individual cognition is made up of nothing

more than names, concepts and labels which are used to structure reality.” (Burrell and Morgan

1979, p. 4) For the nominalists, these labels and names are artificial creations which are used for

describing, making sense of and negotiating the external world. The nominalists assume that the

social world is created by individuals.

According to the realist however, social world is not created by individuals but exists separate from

their perception of it. People are born into and living within a social world which has a reality of its

own. Realism claims that the social world is as real as physical world and ontologically it is prior to

the existence and cognition of any human being. Realism claims that the social world external to

individual cognition is a real world made up of hard, tangible and permanent structures that exists

independent of our labels.


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1.4 .1 .1 .2 THE EP IS TEMO LO G IC A L D EB ATE : AN T I-P OS IT IV ISM -POS IT IV IS M

As it was mentioned above, subjectivist see the social world more relativistic. Thus anti-positivists

have the view that it “can only be understood from the point of view of the individuals who are directly

involved in the activities which are to be studied.” (Burrell and Morgan 1979, p. 5) It means that

human activities can only be comprehended from the inside rather than the outside. This viewpoint

assumes that social world can only be perceived through experience and reject that social science can

create any kind of objective knowledge.

Positivist epistemology, on the other hand, assumes that an ‘observer’ can interpret and forecast what

happens in the social world by searching for patterns and relationships between individuals.

Positivists argue that this ‘observer’ can develop a hypothesis in order to find regularities. This

hypothesis then might be verified by an experimental research programme or falsified and does not

considered to be ‘true’. Nevertheless, every positivist agrees that the growth of knowledge is a

cumulative process.

1 .4 .1 .1 .3 THE HUM AN N ATURE DEB A TE : V O LU N TAR ISM -DE TERM IN ISM

This debate is concerned about the behaviour of individuals related to their environment. Subjectivists

have the voluntarism view which assumes that one’s activity is completely independent from the

environment and he/she has his/her own ‘free will’.

Objectivist presupposes the opposite of voluntarism, which is called determinism. The deterministic

view presumes that individuals’ activity is entirely determined by the situation or the environment

they are located.

1.4 .1 .1 .4 THE METHO DO LO G IC A L DE B ATE : IDE O GR APH IC -N OMO THE T IC THE ORY

The ideographic approach to social science is based upon the view that social science can only be

understood by acquiring first-hand knowledge of the subject under investigation. Thus ideographic

approach put a great emphasis on analysing subjective reports. It is done by observing oneself detailed

background and life history by looking at diaries, biographies and journalistic records. “The

ideographic method stresses the importance of letting one's subject unfold its nature and

characteristics during the process of investigation.”(Burrell and Morgan 1979, p. 6)

With the objective view of social science human activities are assumed to be understandable and

predictable by an ‘observer’. Since this ‘observer’ can make hypotheses, nomothetic methodology


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relies on scientific tests like hypothesis testing and the use of quantitative techniques like surveys,

questionnaires, personality tests and standardised research tools for the analysis of data.

1.4.2 ASSUMPTIONS ABOUT THE NATURE OF SOCIETY

1.4 .2 .1 OR DER-CONFLI C T DEBATE

This debate revolves around the different approaches to sociology which either concerned with the

stabilising effects of social order and equilibrium or the change, conflict and coercion in social

structures. The ‘order theorists’ - like Durkheim, Weber and Pareto - have an integrationist view,

seeing the society as relatively stable and based on consensus, while ‘conflict theorists’ - like Marx -

have a coercion view, meaning that they see the society as constantly changing and disintegrating.

Ralf Dahrendorf further explains these two models of society in his work. According to him, the

Order/Integration theory of society is based on the following assumptions:

Every society is built up by somewhat constant and stable elements.

Every society is a well-combined structure of components.

Every component in a society contributes to its maintenance as a system.

Every functioning society is based on a consensus of values.

He also describes the assumptions which Conflict/Coercion theory of society is based on:

Social change is universal, meaning that the society is continually changing.

There are always disagreements and conflicts within the society.

Every member of a society contributes to its disintegration and change.

Every society is based on the coercion of some of its members by others.

Summarising the above mentioned, the following table presents the characteristics of the two models

of society Dahrendorf distinguishes between. (Burrell and Morgan 1979, p. 13)


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Two theories of society: ‘order’ and ‘conflict’

The ‘order’ or ‘integrationist’ view of

society emphasises:

The ‘conflict’ or ‘coercion’ view of society

emphasises:

Stability Change

Integration Conflict

Functional co-ordination Disintegration

Consensus Coercion

1 .4 .2 .1 .1 CR IT IC ISM O F O RDER -C ON FLIC T DEB ATE

While Dahrendorf assumes that the order and conflict models are completely separated from each

other Cohen argues that they are two sides of the same coin. Cohen supposes that we do not need to

rely exclusively on order or conflict model but theories can include elements of both models.

Dahrendorf acknowledges that the different adjectives can be interpreted different way by different

people. Hence these are not completely accurate in describing the debate and can cause

misinterpretation. Therefore, Burrell and Morgan suggest that the order-conflict debate should be

described by the concepts of ‘regulation’ and ‘radical change’.

1.4 .2 .2 ‘REG ULATIO N’ A ND ‘RA DIC AL CH ANGE ’ DIMEN SIO N

Burrell and Morgan use the term 'sociology of regulation' to refer to theorists - like Durkheim, Weber

and Pareto - who are primarily concerned to explore and provide explanations of the unity and

cohesiveness of society. The central issue of this sociology is to understand why society is maintained

as an entity. In other words, it tries to explain why does society not collapse but remain as a system.

Therefore, “It is a sociology which is essentially concerned with the need for regulation in human

affairs.” (Burrell and Morgan 1979, p. 17)

'Sociology of radical change’, on the other hand, refers to theorists – like Marx – who are concerned

to find explanations for the radical change, structural conflict, modes of domination and structural

contradiction within the society. “It is a sociology which is essentially concerned with man's

emancipation from the structures which limit and stunt his potential for development.” (Burrell and

Morgan 1979, p. 17) In other words, while ‘sociology of regulation’ tries to expound the status quo,

‘sociology of radical change’ concentrates on the deprivation of man and potential changes. In order


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to sum up the above, Burrell and Morgan have made a table which clarifies the differences between

their two sociologies.

The regulation – radical change dimension

The sociology of Regulation is concerned

with:

The sociology of Radical Change is

concerned with:

The status quo Radical change

Social order Structural conflict

Consensus Modes of domination

Social integration and cohesion Contradiction

Solidarity Emancipation

Need satisfaction Deprivation

Actuality Potentiality

1.4 .2 .3 TWO DI MENS ION S : FOU R PA RA DIGM S

The previous two sections of methodology discussed the assumptions about the nature of social

science, using the subjective-objective dimension, and the assumptions about the nature of society,

using regulation-radical change dimension. It was done in order to find the right approach to social

theory. The following two-dimensional map, with the subjective-objective dimension on the

horizontal axis and the regulation-radical change dimension on the vertical axis, shows the possible

combination of approaches to social science, i.e. the four paradigms. (Burrell and Morgan 1979, p.

22) These four paradigms namely are the ‘Radical humanist’, ‘Radical structuralist’, ‘Interpretive’

and ‘Functionalist’ paradigm which will be further discussed below.


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Four paradigms for the analysis of social theory

1.4 .2 .3 .1 THE FUNC T ION A LIS T P AR AD IG M

Functionalist theorists support sociology of regulation from an objectivist point of view. They try to

find explanations of the status quo, social order, consensus, social integration, solidarity, need

satisfaction and actuality. As a result of the objectivist standpoint it approaches social science from a

point of view which tends to be realist, positivist, determinist and nomothetic. Its overall aim is to

provide rational explanations of social affairs which can be measured by science. It is assumed to be

the primary paradigm for organisational study.

1.4 .2 .3 .2 THE IN TERPRE TIV E P AR AD IGM

Theorists who follow the interpretive paradigm also favour sociology of regulation but from a

subjectivist standpoint. It means that these theorists try to explain the status quo, social order,

consensus, social integration, solidarity, need satisfaction and actuality from the individuals’ point of

view. In other words they try to understand the fundamental nature of the society based on their

subjective experiences.

1.4 .2 .3 .3 THE RAD IC AL HUM AN IS T P AR A D IGM

Theorists located within this paradigm advocate sociology of radical change from a subjectivist

viewpoint. It has similarities with the interpretive paradigm in terms of the approach to social science.

Both the interpretive paradigm and radical humanist paradigm view the social world from a

perspective which tends to be nominalist, anti-positivist, voluntarist and ideographic. However,

radical humanists are not concerned with the explanation of stability but the radical change, modes

of domination, emancipation, deprivation and potentiality. The central issue of this paradigm is that


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individuals should tear themselves away from social patterns and realise their full potential. In other

words, this paradigm criticises the status quo by declaring that social constraints limit human

development.

1.4 .2 .3 .4 THE RAD IC AL STRUC TUR A LIS T P AR AD IGM

Just like the previous paradigm, radical structuralist paradigm also supports sociology of radical

change, nevertheless from an objective view. Further disparity that this paradigm argues that radical

change is a fundamental part of the nature of society and inherent structural conflicts generate

constant change through political and economic crises.

1.4.3 THE CHOSEN PARADIGM

This section of methodology is going to explain the chosen approaches to social science and sociology

in order to find the actual approach to social theory. It discusses the four sets of philosophical

assumptions related to ontology, epistemology, human nature and methodology, in accordance with

the ‘Subjective-Objective dimension’. This discussion will tell us whether this project has a subjective

or an objective approach to social science. In other words, it shows the horizontal direction on Burrell

and Morgan’s paradigm model. Moreover, this section reveals the assumptions about the nature of

social science, applying the ‘Regulation-Radical change dimension’. By doing this, we can clearly

see the right direction on the vertical axis on this four paradigm model. After the above discussions

we will see which quadrant of Burrell and Morgan’s matrix suits the best to my approach to social

theory. In short, we can see the actual paradigm that fits the best to this project.

In terms of social science, the objectivist view suits the best to the philosophical assumptions. In the

following, this approach will be explained by the four sets of assumption.

Ontology is concerned with the individual’s view on how reality is created. On the one hand, Tesla

is somewhat creating its own reality by building charging stations and negotiating with government

representatives about government incentives, which represents the subjectivist approach of

nominalism. On the other hand, Tesla’s reality exists irrespectively of the company as the most

important decisions influencing the company’s environment are ultimately in outsiders’ hands.

Realism assumes the social world is not created by individuals but exists separate from their

perception of it. The objective realism of the ontological assumption is therefore seen to be the best

fit for solving the problem.


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Epistemology is concerned with how knowledge is obtained and passed on to others. The aim of this

project is to make an unbiased third-party evaluation of the fair value of one Tesla share. As it was

mentioned above, positivist epistemology assumes that an ‘observer’ – the researchers of this project

– can interpret and forecast the changes within the society. Therefore, the objective positivist

approach is the best to understand the subject of investigation.

Human nature is concerned with the relationship between humans and their environment. As it was

mentioned above, Tesla is somewhat trying to manipulate its environment but it is important to note

that the company does it because it is forced by the current environment. As an example, Tesla would

not build charging stations if they were already available. The deterministic view assumes that one’s

activity is determined by its situation or environment. The objective determinism of human nature

hence best describes the relationship between Tesla Motors and its environment.

The chosen approaches to the above assumptions determine the actual methodological approach as

well. This project mainly relies on quantitative data, which will be further discussed below, in order

to answer the problem statement. These are mostly secondary data, based on quantitative methods,

which reflects the objective nomothetic methodology.

In terms of regulation-radical change dimension, the best-suited approach is sociology of regulation.

Even though Tesla’s stock is characterised by high historical volatility, meaning radical changes in

the price, the aim of this paper is to suggest the fair value of one Tesla share given the company’s

external and internal environments. Sociology of regulation tries to find an explanation for the status

quo so does this paper.

On the basis of the aforementioned, with the objective dimension on the horizontal axis and the

regulation dimension on the vertical axis, ‘Functionalist’ paradigm is argued to be the best

paradigmatic view to solve this problem statement.


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1.4.4 RESEARCH DESIGN

Chapter 1

Problem formulation

Introduction Problem statement Delimitation Methodology

Chapter 2 Tesla Motors & Automotive Industry

Chapter 3

Strategic Analysis

External analysis:

PEST

Industry analysis:

Porter’s five forces

Internal analysis:

Value chain & VRIO SWOT

Chapter 4

Financial Statement Analysis

Accounting policies Reformatting Financial analysis

Forecasting

Chapter 6

Valuation

Discounted Cash Flow model Economic Value Added model

Chapter 7 Sensitivity Analysis

Chapter 8 Conclusion

Chapter 5


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1.4.5 STRATEGIC ANALYSIS

Strategic analysis is performed to get an understanding of the external and internal factors that affect

the company’s cash flow potential and risk. The aim is to identify the non-financial value drivers that

can have an effect on the value creation in the company. Therefore, findings of this section will

influence financial value drivers and serve as foundation for the forecasting of future performance.

The analysis follows a top-down approach that aims at understanding the company’s macro-,

industry-, and company specific factors influencing the cash flow generation and risk.

1.4.5 .1 EXTERN AL A NAL YSI S : PEST-AN ALY SIS

PEST is an acronym for Political, Economic, Social and Technological. PEST-analysis is a strategic

management tool that will be used to help determining how these four external factors affect the

company’s performance in the long-run. It enables the reader to gain a complete overview of the

factors in the macro environment that can have an effect on Tesla Motors.

The PEST analysis, however, has some limitations. First of all, there is a probability of the model not

taking into account all the relevant factors that affect the company’s operations. It is because some

data are hard to gather or not available at the time of analysis. Furthermore, external factors examined

in PEST analysis are dynamic and they can change very fast. This can quickly lead to outdated

assumptions, as the model provides only a static view of the factors, thus making harder to predict

why and how these factors might affect the future of the company.

1.4.5 .2 IND USTR Y A NAL YSI S : PO RTER’S F IVE FO RCES

Following the external analysis I will narrow down the focus of investigation into industry-level.

Porter’s five forces analysis highlights different forces affecting the competition in an industry and

the possibility of earning acceptable returns, i.e. returns equal to or above the cost of capital. The

model investigates the bargaining power of suppliers, bargaining power of buyers, the level of

competitive rivalry, threat of substitutes and threat of new entries. The goal is to determine whether

this is an attractive industry for Tesla Motors to be a part of and what the growth and profit potentials

are.

The Porter’s five forces model also has the same criticism of only generating snapshots. According

to Thurlby (1998), Porter’s model does not take time into consideration, thus providing a static picture

of the industry structure. This requires continuous creation of new models.


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1.4.5 .3 INTERN AL A NAL YSI S : PO RTER’S VALUE CHAI N & VRIO FR AME WO RK

Once we have the broad picture of Tesla’s environment, it is time to examine its internal situation. A

value chain is a group of activities that an organization performs to create value for its customers.

Porter’s value chain will be used to examine Tesla’s activities and see how they are connected. The

purpose is to identify core capabilities of the company by concentrating on organizational strengths

that creates value for customers and provides a competitive advantage. Then the VRIO framework

will be used to summarize the findings of the value chain analysis and determine whether Tesla’s

internal resources and capabilities can provide sustainable competitive advantage.

1.4.5 .4 SWOT A NAL YSI S

SWOT analysis will be the last part of the strategic analysis where key issues will be identified based

on the external, industry and internal analyses. It is only at this point of the analysis that an accurate

assessment can be made of the company’s strategic drivers. It helps determining where the company

stands and what changes are needed to achieve strategic objectives.

Nadine Pahl and Anne Richter, nevertheless, argue that the results of a SWOT analysis are dependent

on the person conducting the analysis, and therefore a subjective view is taken on it. This results that

the findings of the SWOT analysis may vary depending on who the researcher is. They argue that the

conclusion may be inaccurate, if researchers do not have sufficient knowledge of the industry (Pahl

and Richter 2009, p. 28).

1.4.6 F INANCIAL ANALYSIS

Analysis of Tesla’s historical financial performance will be done to determine trends in financial

value drivers. The main focus will be on the company’s operating efficiency, asset use efficiency and

both short-term and long-term liquidity risk.

Findings should be carefully examined as financial ratios are based on historical accounting data. It

is therefore doubtful whether these ratios can paint a correct picture of the company’s future

performance.4

4 Petersen & Plenborg (2012), Financial Statement Analysis, p. 158


20

1 .4.7 FORECASTING

Forecasting assumptions will be derived from the assessment of strategic and financial value drives.

These assumptions will serve as foundation for preparing Tesla’s pro forma income statement and

balance sheet. The aim is to determine future operating profitability and how operations are funded.

1.4.8 VALUATION

Valuation approaches are classified into four main groups, namely, Present value approach, Relative

valuation approach or Multiples, Liquidation approach and Contingent claim valuation models.

According to Petersen & Plenborg, Present value approach and Multiples are the most frequently

used valuation models. They also argue that companies in the early stage of their lifecycle are not

directly comparable with those companies later in their lifecycle, even if they are within the same

industry.5 Tesla is still in its introduction stage of its lifecycle that will be further discussed below.

Since Tesla’s competitors operate in a mature industry, Relative valuation approach is not applicable.

Consequently, I use Present value approaches, such as the Discounted Cash Flow approach (DCF)

and the Economic Value Added model (EVA). The DCF approach uses future free cash flow

projections and discounts them by using the company’s weighted average cost of capital (WACC) to

calculate company value. According to the EVA model, the value of a company is determined by the

sum of the initially invested capital and the present value of all future EVAs. Despite the difference

they are theoretically equivalent valuation approaches, thus should have the same results.6

1.4.9 DATA COLLECTION

The research solely relies on publicly available information that is gathered in the form of secondary

data, also known as desk research. Books, annual reports, research reports, surveys, market data and

online articles are used as main sources.

1.4.9 .1 RELIABIL ITY & VALI DITY OF DAT A

Desk research allows to gather data quickly and at low cost as it does not require the researcher to

travel for interviews to gain primary data. The downside of this type of research is that the quality of

data is considered to be lower than it is in the case of primary data collection. It is because not all

sources used can be verified as hundred percent reliable. Another problem with desk research is that

secondary data collected was not primarily made for the purpose of this paper. Interpretation of these

5 Petersen & Plenborg (2012), Financial Statement Analysis, p. 106 6 Petersen & Plenborg (2012), Financial Statement Analysis, pp. 216-220


21

data, therefore, can vary from person to person. Thus it is possible that one might come to a different

conclusion by using the same information. In order to maintain high reliability of data, it is necessary

to ensure that information is gathered from credible sources. Reliability is accomplished by using the

work of widely acknowledged scholars like Burrel and Morgan, and relying on trustworthy sources

such as Forbes, Bloomberg, NASDAQ, etc. Validity of information is determined by the extent to

which the research measures what it was planned to measure (Joppe 2000, p.1). As all information

collected helps in answering the research question, data used is assumed to be valid.

CHAPTER 2 – TESLA MOTORS & AUTOMOTIVE INDUSTRY

2.1 TESLA MOTORS

Tesla Motors is an innovative company that designs, develops, manufactures and sells high-

performance completely electric vehicles, sophisticated electric vehicle powertrain components and

stationary energy storage systems. 7 Tesla’s mission is to accelerate the world’s transition to

sustainable transport. It was originally founded in July 2003 by Martin Eberhard and Marc

Tarpenning who wanted to prove that electric cars could be as good as gasoline-powered cars or even

better.8 In October 2008, Elon Musk, who was already a member of the board of directors and by this

time had invested USD 70 million of his own money into Tesla, succeeded as Chief Executive Officer

(CEO) and is holding this position to this day.9

On June 29 2010, the company went public on NASDAQ stock exchange under the symbol “TSLA”,

with an Initial Public Offering (IPO) of USD 17 per share. While total revenues increased from USD

3.19 billion in 2014 to USD 4.04 billion in 2015, its net loss has increased from USD 294 million to

USD 888 million in respective years, leading to a current market cap of USD 31.78 billion.10,11

2.1.1 THREE-STEP MASTER PLAN

Tesla has a three-step master plan for bringing electric vehicles to mass market. The first step is to

start with a high-price/low-volume car, followed by mid-price/mid-volume models, and finally

produce low price vehicles in high volume. The reason for this strategy, according to Elon Musk, is

that “in order to make any technology mass market it takes time, you have got to go through major

7 Tesla Annual Report (2014), p. 4 8 TechCrunch (28.07.2015), “A Brief History Of Tesla” 9 Tesla Motors (23.05.2016), “Board of Directors Elon Musk” 10 Tesla Annual Report (2015), p. 48 11 Reuters (23.05.2016), “Tesla Motors Inc”


22

design iterations”, and to raise funds, “people will only give you money if you have shown some prior

success”.12 In other words, initially the company should target the premium segment with a smaller

number of high-performing, more expensive vehicles to gain public awareness and cover some of the

initial high costs of the new technology to be able to support cheaper models in the future for the

mass market.

2.1.2 VEHICLES AND ENERGY STORAGE APPLIC ATIONS

Up till now Tesla has achieved two out of its three-step master plan and it plans to achieve the third

step in late 2017.

2.1.2 .1 TE SLA ROA DSTE R

The company has accomplished the first step by launching the Tesla Roadster in 2008, which was the

first ever mass manufactured electric sports car.13 It was an impressive start for the company, as its

first full-electric car could accelerate from zero to 60 miles per hour in 3.7 seconds with a maximum

speed of 120 miles per hour and 245 miles range on a single charge, thereby painting a rather different

picture of what car buyers had in their mind about electric cars. With its USD 109,000 base price the

Roadster naturally belonged to the luxury category. Approximately 2500 units were sold when the

company stopped production in January 2012.14

2.1.2 .2 M ODEL S AN D M ODEL X

The second step of the master plan was first accomplished by the deliveries of Model S in June 2012,

and later by handing over the keys for the first Model X owners in September 2015.

Model S is a fully-electric, five-adult passenger premium sedan with a starting price of USD 70,000

before incentives, up to 288 miles range and a zero to 60 miles per hour acceleration in as little as 2.8

seconds with the company’s latest “ludicrous mode” upgrade.15 According to Tesla Motors, Model S

is the fastest-accelerating sedan on the road and has become the best-selling electric vehicle in the

United States in the first half of 2015. The Model S has won several awards, including Motor Trend

Car of the Year in 2013, received the highest customer satisfaction score by Consumer Reports for

two years in a row, and earned the highest safety rating in the U.S. by the National Highway Traffic

12 CBS News (04.02.2014), “Elon Musk says Tesla is following his master plan” 13 Motor Authority (11.04.2010), “The World`s Only Electric Sports Car: 2010 Tesla Roadster” 14 Tesla Annual Report (2014), p. 6 15 Tesla Motors (02.10.2015), “Model S”


23

Safety Administration (NHTSA).16 So far, Model S is the company’s best-selling model with an

estimated sales of 109,870 by the end of 2015.17

Model X is an electric-powered, all-wheel drive, seven-seat sport utility vehicle (SUV), with a range

of 257 miles on a single-charge and an acceleration of 3.2 seconds from zero to 60 miles per hour in

“ludicrous mode”.18 It is claimed to be the safest SUV ever, according to Elon Musk, due to its

outstanding scores in collision tests compared to its best-performing competitive SUVs, and an

overall five-star rating by the NHTSA. For maximum safety, the model comes standard with active

safety system which includes automatic emergency breaking and side-collision avoidance. Falcon

Wing doors are one of the unique characteristics of this model that is designed to give easy access to

second and third row seats even in such small spaces where traditional SUV doors would fail.19 It

comes with a base price of USD 69,300, although the first signature models, equipped with all extras

available, came with a rather higher price tag of USD 132,000.20

2.1.2 .3 M ODEL 3

The company unveiled its third generation electric vehicle, called Model 3, in March 2016 and starts

production in late 2017. This would be a 20 per cent smaller but considerably cheaper product than

the Model S. Smaller size, however, means smaller battery size and shorter range of approximately

215 miles per charge and a zero to 60 miles per hour acceleration under 6 seconds. Elon Musk,

moreover, ensured that the new model will receive top safety ratings as all of the previous models.

However, it is important to note that the final product could have slightly different parameters.

Different battery sizes will be available to choose from, providing higher range and better

performance. It would likely powered by one of the smaller motors currently used in Model S. This

would mean that Model 3 would utilize many parameters of the previous models, which would lead

to higher cost-efficiency and lower base price. As production of Model 3 would only take place once

the Gigafactory is fully operational, battery packs are assumed to be at least 30 per cent cheaper to

produce than it was for the earlier models, which would mean further drop in the base price of Model

3. The expected starting price of USD 35,000 before government incentives makes this car a lot more

affordable for the mass market than the previous models.21 Strong demand for the cheaper model can

16 Tesla Motors, Second Quarter 2015 Shareholder Letter 17 Calculated by author, using Tesla’s annual reports, as the following: 2650+22477+34291+50452=109870 18 Tesla Motors (02.10.2015), “Model X” 19 Model X Launch Event (29.09.2015) 20 Bloomberg Business (01.10.2015), Tesla Model X Pricing: A Safe $132,000 Bet” 21 TESLARATI (26.05.2015), “What We Know About the Tesla Model 3 and What We Don’t”


24

be seen by the surprisingly high number of pre-orders. Within only twenty-four hours, Tesla has

received 180,000 pre-orders and 325,000 pre-orders within the first week. These are extremely high

numbers, considering that the company has only sold approximately 100,000 vehicles until the reveal

of Model 3.22,23 According to Tesla, the number of pre-orders corresponds to USD 14 billion in

implied future sales. This is more than three times higher than the company’s all time maximum

revenue of USD 4 billion in 2015. By delivering Model 3, Tesla would achieve the third step of its

master plan, which is a low-price/high-volume electric vehicle that would most likely improve the

financial position of the company.

2.1.2 .4 ENERG Y STOR A GE APPLIC ATION S

Using existing technologies developed for its vehicle powertrain systems, Tesla has entered the

energy storage market by producing battery systems for both home and commercial use. Tesla

Powerwall is a rechargeable lithium-ion battery with a storage size of 10kWh designed for residential

use. Tesla 100 kWh PowerPack is designed for commercial use that can be grouped together to

provide 10mWh+ for utility scale system. Primary use of these battery systems are backup power,

peak demand reduction, demand response and wholesale electric market services.24 Even though it is

a new market for Tesla, only a small fragment of its income stems from Tesla Energy products. Due

to its negligible effect on the company’s finances, this paper does not analyse the energy storage

market.

2.1.3 H ISTORICAL EVENTS & SHARE PRICE DEVELOPME NT

It has been a long time since an American automobile company went public. Tesla’s IPO was the first

by an American car manufacturer since Ford Motor Co. in 1956.25 TSLA share is characterised by

high degree of volatility. At the time of IPO, one TSLA share cost USD 17 and it has reached an all-

time maximum of USD 286.64 on 20 July 2015, but traded at USD 216.22 on 23 May 2016. It means

that the share price has increased with a Compounded Annual Growth Rate (CAGR) of approximately

76 per cent as of 20 July 2015 and 53 per cent as of 23 May 2016.26 High fluctuation of TSLA share

22 The Wall Street Journal (01.04.2016), “Tesla’s Model 3 Electric Car Gets Requests for 180,000 Vehicles on First Day of Ordering” 23 The Verge (07.04.2016), “Tesla has received 325,000 preorders for the Model 3” 24 Tesla Motors (08.04.2016), “Tesla Energy” 25 MarketWatch (28.06.2010), “Tesla Motors revs up $244 million IPO” 26 (284.64/17)^(1/5)-1=0.76; (216.22/17)^(1/6)-1=0.53


25

price over the years was due to, inter alia, the company’s performance, analyst reports, unexpected

events and the CEO’s statements.

Source: Compiled by author/NASDAQ/Business Insider/Motor Trend/CNNMoney/International Business Times

Tesla’s share price was relatively stable for more than two years after the IPO, even though Model S

delivery has already begun in the middle of 2012. In May 2013, the company announced its first, and

so far only, quarterly GAAP-based net profit of USD 11.2 million. Consequently, the share price

skyrocketed from USD 55.79 on May 8th 2013 to USD 193 on October 1st 2013, an almost 2.5 times

jump in as little as five months.27 Nonetheless, stock price had a sharp fall after a few Model S caught

on fire and some analysts had negative reports on Tesla Motors and downgraded its stock.28 In less

than two months, TSLA dropped 37 per cent from USD 193 on October 1st to USD 121.11 on 20th

November. The share price development had a positive turn again when the Model S received the

highest owner-satisfaction according to Consumer Reports.29 It had an astonishing price jump of

nearly 14 per cent from one day to another when Morgan & Stanley doubled its price target for Tesla

27 Tesla Motors, First Quarter 2013 Shareholder Letter 28 CNNMoney (03.10.2013), “Tesla stock continues to fall” 29 Business Insider (21.11.2013), “Tesla's Model S Receives 'The Highest Owner-Satisfaction Score Consumer Reports Has Seen In Years'”

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reports

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Delay ofModel X

Weak China sales

Record quarterfor production

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estimates

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Annual report2015

Q1 2016 report

Morgan & Stanley

Gigafactory

'Highstock price'

Power Wall


26

stock.30 Tesla’s share price, however, hit another rock bottom when the first quarterly report of 2014

showed lower than expected Earnings per Share (EPS).31 TSLA rose to new peaks after Tesla Motors,

Inc. and Panasonic Corporation signed an agreement of constructing a large-scale battery

manufacturing plant in Nevada, called the Gigafactory. The company expects significant reduction

in battery production cost and increase in production volume from the Gigafactory that will

completely powered by renewable energy.32 After signing the agreement, Tesla’s share price was so

high that some people, including the CEO, started to question whether the market is too generous. In

September 2014, Elon Musk said that “I think our stock price is kind of high right now to be totally

honest”.33 This statement coupled with another delay of Model X and weak sales in China affected

the share price negatively and resulted a ten-month low of USD 185.34 Share price started to climb

fast again, following Tesla’s announcement of entering the energy-storage market. In April 2015,

Elon Musk revealed the Tesla Home Battery, called the Power Wall, which would mean a more

diverse portfolio for the company.35 Share price has climbed even further after the announcement of

record quarter production, reaching its all times maximum of 286.64 on 20 July 2015. This was

followed by a continuous decrease in price due to lowered delivery estimates. In the beginning of

2016, some analysts have lowered their price target that led to a price drop of more than 25 per cent

in less than ten days, trading Tesla’s share at half price they did less than seven months earlier.36 Once

investors could see the annual report of 2015, share price has risen close to USD 250 again. In its

latest quarterly report, Tesla has announced the advancement of its 500,000 unit build plan by two

years to 2018. To speed up production, however, would require the company to spend more money

than previously stated.37 As a consequence, Tesla’s share was traded close to USD 210 during the

past few weeks.

2.2 THE AUTOMOTIVE INDUSTRY

The automobile industry is highly competitive and demand is characterized by high volatility. 38 The

market had a remarkable growth during the past decade. It has experienced a sixth straight years of

30 International Business Times (25.02.2014), “Tesla (TSLA) Stock Soars After Morgan Stanley Report: Could Elon Musk's 'Giga Factory' Disrupt Entire Electric Utility Industry?” 31 Autoblog (07.05.2014), “Tesla loses $50 million in Q1, Model X could be delayed until 2015” 32 Tesla Motors (31.07.2014), “Panasonic and Tesla Sign Agreement for the Gigafactory” 33 Forbes (05.09.2014), “Elon Musk: Tesla Stock Price 'Kind Of High Right Now'” 34 Bidness Etc (15.01.2015), “After Weak China Sales, Is Tesla Motors Inc Facing Trouble In Europe?” 35 CNBC (07.05.2015), “Tesla's new bet: A home battery to slash energy costs” 36 Fortune (05.02.2016), “Here's What's Behind Tesla's Long, Slow Stock Slide” 37 Internatonal Business Times (05.05.2016), “Tesla Motors Inc. (TSLA) Shares Fall” 38 Tesla Annual Report (2014), pp. 26-27


27

record sales in 2015, indicating that the global recession is now behind the industry. After the financial

crisis, a shift in global sales ratio has occurred. Since 2010, gradually growing emerging markets

accounted for more than half of global light-vehicle sales, with China providing the highest single

market sales.39 Meanwhile, passenger cars remained the core segment, adding up to 74 per cent of

the industry.

Source: Compiled by author / OICA / KPMG

Global sales of passenger cars rose from 45.2 million in 2005 to 66.3 million in 2015, an increase of

46.6 per cent and a CAGR of 3.9 per cent. According to KPMG, there will be 111 million light

vehicle sales by 2020 of which, given the current rate, approximately 82 million would be passenger

cars.40 This would require a CAGR of 4.4 per cent, which is a slightly bullish estimate, given the

slowing sales growth rates that will be further discussed below.41 When using past CAGRs, it is more

likely that the number of new passenger car sales will be between 79 and 80 million units.42

Distribution of sales volumes largely differs across the globe before and after the crisis. In the middle

of the previous decade, the European Union sold the highest number of passenger cars of 15.6 million,

followed by the USA of 7.6 million and China of 3.9 million. During the crisis, sales both in the EU

and in the U.S. have dropped drastically while sales in China have skyrocketed. By 2011, China was

the leading market in terms of passenger car sales with an annual sales of 14.4 million, followed by

Europe of 13.6 million and the USA of 6 million.

39 Standard & Poor’s (2013), “The Global Auto Industry Shifts Its Focus To Overseas and Emerging Markets” 40 KPMG (2015), “KPMG`s Global Automotive Executive Survey”, p. 12 41 CAGR=((111,000,000/66,311,917)^(1/5))-1=4.4% 42 Five year CAGR=3.6%, Ten year CAGR=3.9%; 66,311,917*(1.036)^5=79,066,099; 66,311,917*(1.039)^5=80275964

0

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70000000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Passenger car sales

China European Union USA World


28

Source: Compiled by author / OICA

The above column chart shows that China has mostly gained sales volume in proportion to the

European Union, although the EU showed improvements in the last year. In 2015, China was the

largest market, responsible for 32 per cent of global passenger car sales, followed by EU of 22 per

cent and the USA of 11 per cent. As we can see, China clearly benefited more from the market

conditions of the past decade than any other region. It is, therefore, no surprise that Tesla Motors has

entered the market in 2014.43


43 Tesla Annual Report (2014), p. 47

9% 11% 12% 14%21% 25% 25% 26% 28% 30% 32%

35% 33% 32% 30%29% 25% 24% 21% 20% 20% 22%

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Sales ratio of passenger car sales by region

China European Union USA Rest of the world

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It is important to note that the above mentioned trend is might subject to change. Worldwide

passenger car sales growth has become modest during the past few years. Although China had the

highest growth rates over the past decade, sometimes reaching above 50 per cent increase, it is now

producing slowing growth figures. Meanwhile, the European Union, who suffered the longest from

the crisis, shows such great improvements that it has become Tesla’s fastest growing passenger car

market last year. The U.S. showed some impressive growth recovery between 2009 and 2012, but it

was again suffering from negative growth in 2015. In overall, worldwide passenger car sales indicate

a setback in growth from 12.4 per cent in 2010 to 1.4 per cent in 2015. Moreover, there is a shifting

trend with the European Union becoming an increasingly important car market, while the U.S. and

the rest of the world are losing ground. Although China is the world’s largest car market and still has

above average growth figures, it faces with slowing growth rates in the passenger car segment.

2.2.1 THE ELECTRIC VEHICLE MARKET

The market for electric vehicles (EVs) is currently a small but gradually significant segment of the

automobile industry. Governments from all around the world wish to increase the magnitude of EVs

on the road due to their economic and environmental benefits. On the one side, state regulations

inspire car manufacturers to develop EVs. On the other side, government incentives encourage

customers to buy them.44

2.2.1 .1 ELE CTRI C VEHI CLE SEGMENT S

The electric vehicle market consists of three main segments, namely, Hybrid Electric Vehicles

(HEVs), Plug-in Hybrid or Plug-in Hybrid Electric Vehicles (PHEVs) and Battery Electric Vehicles

(BEVs). Each of the electric vehicle segment has different operating principle:45

HEVs: vehicles that are powered by both an internal combustion engine (ICE) and a battery

pack. The battery is charged with regenerative breaking hence the vehicle can only be

refuelled with petroleum. The 2016 Ford Fusion Hybrid is a fine example of HEVs.46

PHEVs: these vehicles are similar to HEVs as they are powered by both an ICE and a battery

pack, but the battery should be recharged by plugging the vehicle into an external electric

44 Navigant Research (2014), “Electric Vehicle Market Forecasts”, p. 1 45 Emotive (2014), “The Beginners Guide to Electric Vehicles (EV)”, p. 3 46 ford.com/cars/fusion


30

source. Therefore, PHEVs need both petroleum and external charging to reach maximum

capacity. A good example of PHEVs is the Chevrolet Volt.47

BEVs: vehicles that are solely powered by battery packs that should be recharged by an

external electric source. While lithium-ion battery provides the longest range for today’s

BEVs, hence probably the most likely choice of EV manufacturers, its higher production price

places lithium-ion battery-equipped EVs to the premium category. Tesla models are prime

examples of BEVs.

2.2.1 .2 ELE CTRI C VEHI CLE M ARKET PROGN OSI S

KPMG’s survey, in which two hundred senior automotive executives from the world’s leading car

manufacturing companies were participated, represents a notable increase of the EV market.48

Source: Compiled by author / KPMG

The column chart shows the percentage share of overall powertrain production volume in respective

years according to the survey. Senior automotive executives assume that EV manufacturing is going

to more than double in proportion from 1.51 per cent of total production in 2011 to 4.57 per cent in

2020.49 Although HEVs give majority of EV sales during this interval, they are slowly losing ground

to PHEVs and BEVs. Whereas more than 90 per cent of the segment is provided by HEVs in 2011,

47 chevrolet.com/volt-electric-car 48 KPMG (2015), “KPMG`s Global Automotive Executive Survey”, p. 18 49 0.12%+1.39%=1.51%; 0.62%+0.99%+2.96%=4.57%

1,39%

2,18% 2,16%2,50% 2,62% 2,76% 2,86% 2,97% 3,00% 2,96%

0,07% 0,10%

0,19%0,36%

0,53%0,68%

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0,12%

0,14% 0,18%

0,32%0,38%

0,44%0,49%

0,55% 0,60% 0,62%

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Electrified powertrain production forecast

HEV PHEV

BEV


31

it is predicted less than 65 per cent in 2020.50 Both PHEVs and BEVs are expected to have higher

growth rate, indicating a market trend in the foreseeable future. Nonetheless, it shall not be ignored

that this survey also suggests gradual slow-down in the growth of EV market. Thought the segment

grew by almost 60 per cent from 2011 to 2012, it is expected to grow by less than 2.5 per cent from

2019 to 2020.51

CHAPTER 3 – STRATEGIC ANALYSIS

3.1 EXTERNAL ANALYSIS: PEST ANALYSIS

PEST analysis helps determining how Political, Economic, Social and Technological factors affect

the activities and performance of Tesla Motors in the long-term. The figure below demonstrates how

these macro factors are related to the firm.

Figure: Macro environmental factors affecting a firm

3.1.1 POLITICAL FACTOR S

Political factors represent governmental acts and legal issues influencing the macro environment of

a firm. Governments, in general, face two alternatives in having a legal impact on a given industry

and its members. They can either force government regulations or provide government incentives.

3.1.1 .1 GOVE RNME NT REGULATIO NS

Governments can choose a more direct approach to affect automotive industry by forcing industry

players to manufacture vehicles that meet the current regulatory requirements in terms of safety, fuel

50 1.39%/1.51%=92.05%; 2.96%/4.57%=64.77% 51 (2.39%-1.51%)/1.51%=58.28%; (4.57%-4.47%)/4.47%=2.24%


32

economy and green-house gas (GHG) emission standards. Moreover, the way companies can sell

their vehicles is also regulated by government laws. In this section, I have a special focus on fuel

economy, GHG emission standards and dealership laws, as I see them the most relevant political

factors influencing the macro environment of Tesla Motors.

The following figure depicts the different CO2 passenger car standards around the world by

converting all regulatory programs to be comparable with the European method.

International CO2 passenger car standards

[1] China’s target reflects gasoline vehicles only. The target may be higher after new energy vehicles are considered.

[2] US standards GHG standards set by EPA, which is slightly different from fuel economy standards due to low-GWP refrigerant credits.

[3] Gasoline in Brazil contains 22% of ethanol (E22), all data in the chart have been converted to gasoline (E00) equivalent

Source: The International Council on Clean Transportation

In light of the successful adoption of the first National Program for GHG and fuel economy standards

for model years 2012 through 2016 vehicles, President Obama requested the Environmental

Protection Agency (EPA) and the NHTSA to develop a second phase of the program, with improved


33

standards for model years 2017-2025 vehicles. 52 EPA sets national GHG standards under the Clean

Air Act, while NHTSA establishes Corporate Average Fuel Economy (CAFE) standards under the

Energy Policy and Conservation Act. The first phase required new passenger cars to meet an emission

level of 225 grams of carbon dioxide (CO2) per mile in model year 2016, or 37.8 miles per gallon

(mpg). In phase two, standards have been increased for the upcoming years, with an emission level

of 143 grams of CO2 per mile (93g/km) in model year 2025, which is equal to 56.2 mpg.53 This would

mean that, in case of successful adoption of the National Program phase two, new vehicles in 2025

should have only half of the GHG emission level of new vehicles produced in 2010. These are fairly

high level of improvements that, according to EPA, will most likely be achieved through

advancements in internal combustion engines, transmissions, aerodynamics, weight reduction, lower

tire rolling resistance and last but not least through electrification, meaning higher production of

stop/start system, HEVs, PHEVs and BEVs.

The European Parliament and the Council of the European Union accepted the proposal of the

European Commission in regard to reduce CO2 emission from light-duty vehicles by setting emission

performance standards for new passenger cars. In this respect, the European Parliament and the

Council agreed that developed countries in the European Union should strive to achieve 30 per cent

reduction in greenhouse gas emission by 2020 compared to 1990 levels, and the Union itself should

accomplish 20 per cent reduction for the same interval, disregarding developed countries. According

to this, the average CO2 emission for new passenger cars should not exceed 130 g/km from 2015, and

95 g/km from 2020. The European Parliament proposed a target range of 68-78 g/km for 2025 of

which the European Commission should review by 1 January 2017.54 The Commission sees these

targets achievable through improvements in vehicle motor technology and implementation of

innovative technologies aimed at producing more eco-friendly vehicles. Manufacturers whose

average CO2 emission exceed these targets should pay an excess emission premium in each calendar

year. The higher the average CO2 emission level compared to the Commission’s target, the higher

excess emission premium should be paid (see Appendix 1).55

52 United States Environmental Protection Agency (2012), “EPA and NHTSA Set Standards to Reduce Greenhouse

Gases and Improve Fuel Economy for Model Years 2017-2025 Cars and Light Trucks”, p. 10

53 ICCT (2014), “UNITED STATES LIGHT-DUTY VEHICLE FUEL EFFICIENCY STANDARDS” 54 ICCT (02.05.2013), “EU vote on cars CO2: 95 g/km in 2020, 68-78 g/km in 2025” 55 Official Journal of the European Union (2009). REGULATION (EC) No 443/2009 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL


34

Companies facing with tighter government regulations over time, however, may try to trick the

system to seemingly comply with government standards. Volkswagen’s emission cheating scandal is

a prime example of such an attempt. It was revealed that Volkswagen Group has cheated on emission

tests. It had built a ‘defeat device’ in many of its diesel cars, which activated once the car has been

tested. The German automaker first denied the accusations, claiming that discrepancies between

pollution tests were just technical errors. Only when EPA has threatened to withhold approval for the

company’s 2016 diesel models, Volkswagen admitted the charges. The scandal has affected 11

million vehicles and raised awareness in the whole automotive industry. Volkswagen should fix the

problem in a timely manner or else its vehicles will be recalled by the authorities. It also faces lawsuits

from costumers claiming compensation for the resale value drop of their vehicles.56 The scandal may

paint a negative picture of the diesel car industry in particular, which is one of the main alternatives

of EVs. This can lead to tighter emission control in the future and a shift in consumer demands to

more trustworthy segments of the industry. Consequently, EV segment and Tesla Motors might

benefit from events like this in the future.

The China Automotive Technology and Research Center (CATARC) in collaboration with multiple

agencies of the Chinese government drafted the regulations for China’s first-ever fuel consumption

standards for passenger vehicles in 2004. Phase III of the fuel consumption regulation established a

corporate-average fuel consumption (CAFC) target for new vehicles of 7 L/100 km, equivalent to

CO2 emission of 167 g/km. Phase IV of the regulation has entered into force in 2016 that set a fleet

average target for new vehicles of 5 L/100 km, or 117 g/km by 2020. It is important to mention that

these regulations offer automakers some flexibility to comply. Producers that use off-cycle fuel

saving technologies on their cars, such as start-stop, gear shift indicators, tire pressure monitoring and

efficient A/C systems, can claim up to 0.5 L/100 km fuel consumption credit if all these technologies

are adopted on their cars.57

As it was mentioned above, governments also influence the way companies can distribute their

vehicles. Tesla is currently fighting legal battles to be able to sell its vehicles in its domestic market.

As of 31st December 2015, Tesla was only allowed to open stores and sell directly to customers in

about 20 states. States like Michigan, Connecticut or Texas, however, ban direct retail sales.58 The

aim of restrictions is to prevent manufacturers from undercutting prices and drive dealers out of

56 BBC News (04.11.2015), “Volkswagen: The scandal explained” 57 Transportpolicy.net (22.09.2015), “China: Light-duty: Fuel Consumption” 58 The Pew Charitable Trust (16. 12. 2015), “For Tesla, a Fight to Sell in Some States”


35

business, thereby lessening the level of competition. One of Tesla’s biggest challenges, therefore, is

to win the right to sell its vehicles directly to customers. This requires the company to fight multiple

legal battles at the same time that can be money and time consuming.

3.1.1 .2 GOVE RNME NT INCENTI VES

In this section I focus on government incentives provided for the EV segment, due to their relevance

in answering the problem statement. Governments can choose a less-direct approach to influence the

macro environment by providing both supply side and demand side incentives to shift automotive

industry toward greener technologies. On the supply side, incentives help manufacturers conduct

research and development to enter the EV market. On the demand side, governments aimed at driving

down the initial cost and the operating cost of EVs through financial and non-financial incentives to

encourage customers to buy them.

Advanced Technology Vehicles Manufacturing (ATVM) loans support the development of advanced

technology vehicles (ATV) in the United States. The Department of Energy (DOE) has a budget of

USD 25 billion to offer ATVM grants and loans for automobile manufacturers and component

suppliers in the United States to produce qualified advanced technology vehicles or qualifying

components which aimed to achieve improvements in fuel economy performance.59 This supply side

incentive program motivates automotive companies to put more EVs on the roads. Tesla has also

taken loans from the DOE that was fully paid back by May 2013.60

Governments around the world provide financial and non-financial incentives in order to encourage

people to choose more eco-friendly cars. In the United States, EVs are currently eligible for up to

USD 7500 federal income tax credit, based on the battery capacity used to fuel the vehicle. This tax

credit, however, will phase out once a manufacturer produced its 200,000th plug-in electric drive

vehicle. Phase out starts at the beginning of the second calendar quarter after the 200,000-vehicle

mark has reached. At that point, EVs from this specific manufacturer will only receive 50 per cent of

the previous credit amount. From the fourth calendar quarter, the amount of tax credit decreases again

to 25 per cent and it ends from the beginning of the sixth calendar quarter after this production mark

has reached by the company.61 According to estimates, Tesla would produce its 200,000th vehicle by

59 Federal Register (2008). Department of Energy: Advanced Technology Vehicles Manufacturing Incentive Program. Vol. 73 (No. 219), pp. 66721-66725. 60 Tesla Annual Report (2015), p. 31 61 Fueleconomy.gov (24.10.2015), “Federal Tax Credits for Electric Vehicles Purchased in or after 2010”


36

2017, after which new Tesla owners would not receive further tax credits unless new settlements have

been reached.62

Today, eighteen out of twenty-eight member states in the European Union provide some sort of

financial incentive for potential electric vehicle owners. Nevertheless, the type and level of these

incentives can vary a lot amongst these countries. In general, these governments offer electric vehicles

exemption from registration tax, annual circulation tax, road tax, company car tax, and in some cases

they even provide grants for owning green cars (see Appendix 2).63

Among the non-EU European countries, Norway offered the highest government incentives for

purchasing and owning EVs. New EV owners did not have to pay purchase tax, which is extremely

high in Norway. In addition, they had an exemption from 25 per cent VAT on purchase. Initially, the

Norwegian Parliament agreed to provide these incentives until 2018 or when 50,000 EV has been

sold. This target has been reached by the middle of 2015, after which government parties had a debate

about the future of these incentives. Finally, they have agreed on maintaining the tax exemptions until

2017 but EV owners have to pay half of the yearly road license fee as of 2018 and the full rate as of

2020. According to newspaper Dagens Næringsliv, however, Tesla models will cost more in Norway

due to its higher initial price than the government-imposed ceiling for the 25 per cent VAT

exemption.64 This is probably one of the reasons for Norway has been bypassed by China in Tesla’s

top selling markets.65

Air pollution is a serious problem in several big cities in China. Chinese policymakers put huge

emphasise on supporting green technology to reduce green-house gas emission, while maintaining

economic growth. National subsidies of RMB 35,000-60,000 (~USD 5,600 – USD 9,500) are

provided for consumers who purchase New Electric Vehicles (NEV) that are produced locally. In

general, all electric vehicles receive nearly twice as much subsidies as HEVs and PHEVs. National

subsidies are offered through 2020 but scaling down each year. Tax exemptions is another way of

encouraging NEV purchase. In September 2014, China’s State Council eliminated the 10 per cent

purchase tax on NEVs manufactured locally, which will proceed through 2017. Furthermore, a

number of local governments offer free licence plates for NEVs. In Shanghai, new Tesla owners can

save an average of RMB 74,000 (~USD 12,000) just on the licence plate. Moreover, several local

62 Tesla Shareholder Letter (Q4 2015), p. 4 63 ACEA (27.03.2015), “Overview of incentives for buying electric vehicles” 64 Newsinenglish.no (07.05.2015), “Electric cars hang on to tax breaks” 65 Forbes (31.17.2014), “Analysis Of Tesla Sales By Geography”


37

governments offer their own incentives that can go as high as the national subsidy, resulting a

maximum purchase subsidy of RMB 120,000 (~USD 19,500) when both national and local subsidies

are provided. China’s determination towards greener future, can also be perceived through the

National Government Offices Administration’s declaration that from 2014, at least 30 per cent of all

new government cars should be NEVs. As a result of these government incentives, China’s NEV

sales jumped by 325 per cent in 2014 compared to 2013 sales.66

The following table summarizes the different financial and non-financial government incentives in

Tesla’s main markets.

Table: Government incentives for electric vehicles in Tesla’s main markets

United States China Norway The Netherlands

Financial

ATVM loans;

maximum of $7500

federal income tax

credit

National subsidies:

$5,600-$9,500

Local subsidies up to

$9,500

Free licence plates:

$12,000

Exemption from:

purchase tax,

25% VAT

Exemption from:

registration tax BPM

(private motor vehicle

tax), annual circulation

tax

Non-

financial

Free parking;

access to high-

occupancy vehicle lane

Free parking lot for

EVs with charging

stations; use of public

transport lanes[1]

Parking lots reserved

for EVs;

free charging in public

parking spaces

[1] Local authorities have the right to allow free parking and use of public lanes

Source: Compiled by author / Fuel Economy / The New York Times / The Telegraph / China Business Review

3.1.2 ECONOMIC FACTOR S

3.1.2 .1 ECO NOMI C DE V ELOPMENT

The latest financial crisis had a negative impact on the entire world economy between 2007 and 2009,

although China was less affected than the European Union or the United States. Even though these

economies have recovered from the crisis, GDP growth rates are decreasing in some of Tesla’s key

markets.

66 China Business Review (2015), “Opportunities and Challenges in China’s Electric Vehicle Market”


38

Source: Compiled by author / The World Bank / European Commission / Trading Economics

The above line chart shows that China had the highest GPD growth rate in the past decade, which is

why it has become critical for global automakers who tried to offset the flagging sales in Europe after

the crisis. As a result, China has become the world’s biggest auto market in 2009.67 China, however,

faces drop in new-car sales growth due to slowing economic growth and rising concern of air

pollution.68 GDP growth in the USA, Tesla’s domestic market, is also expected to slow down. The

European Union, however, is experiencing a slow but steady increase. In general, there is a moderate

world economic growth prospect of 3.76 percent, with China having the highest growth potentials

within Tesla’s main markets, but moving towards the world average.

3.1.2 .2 CYCLI CAL IN DU STRY

Automobile is a cyclical industry, meaning its overall performance is sensitive to the business cycle.

While non-cyclical industries provide goods consumers need on a daily bases, such as water, food

and electricity, cyclical industries typically produce big ticket items, which represent higher value

goods that have a longer useful lifetime. Automobiles are prime examples of such items. Revenues

for companies that operate within a cyclical industry are generally higher in times of economic

prosperity and lower during economic downturn. It is because consumers are more confident in the

booming period, while saving up and postponing big item purchases during recession. 69 As a result,

67 Business Insider (09.01.2014), “China's Booming Car Market Is Terrific News For Western Automakers” 68 International Business Times (08.28.2015), “China Crisis: Automakers Like Volkswagen, General Motors Brace For Impact As China Car Sales Fall” 69 InvestingAnswers (11.12.2015), “Cyclical Industry”

-5,0%

0,0%

5,0%

10,0%

15,0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2020

Historical & forecasted GDP growth

China European Union USA World


39

vehicle sales tend to move with consumer confidence, which is directly related to business cycles and

GDP. The following figure shows the development of world GDP and vehicle sales from 2006

through 2015.

Source: Compiled by author / The World Bank / OICA

As we can see, world GDP and vehicle sales follow a somewhat similar growth pattern. By calculating

the correlation coefficient between the two sets of data, we can determine how sensitive the

automotive industry to business cycles. The closer the result to 1, the higher the correlation, hence

the more sensitive the auto industry to economic performances. The correlation between world GDP

and vehicle sales was 0.72, with the highest correlation in the U.S. of 0.84, followed by the European

Union of 0.56, while China had the lowest correlation of 0.45 (see Appendix 3). According to these

figures, we can see a stronger relation between economic development and vehicles sales in

developed countries while it is less likely the case in emerging economies. GDP growth and vehicles

sales growth, however, do not always have similar pattern. While GDP had a moderate growth,

vehicle sales grew significantly between 2011 and 2012. Due to the financial crisis, people saved up

money and postponed big ticket item purchases. This led to an accumulated demand, which is why

vehicles sales grew at a higher rate, while GDP trended slightly downwards. Nonetheless, an opposite

pattern can be observed since 2012. Although world GDP shows moderate but steady growth,

vehicles sales growth has slowed down. In fact, world vehicle sales had lower growth figures than

total global GDP. The last time this happened, world economy was suffering from the financial crisis.

Therefore, it might be a warning sign of future economic downturn. Nonetheless, if we are to believe

-5,0%

0,0%

5,0%

10,0%

15,0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

World GDP growth & World vehicle sales growth

World GDP growth World vehicle sales growth


40

the World Bank’s moderate economic growth forecast, a moderate growth in vehicle sales can be

expected, given the industry’s cyclical nature.

3.1.2 .3 F I NAN CI AL M AR KET COND ITIO NS

Evidences for the United States and Canada propose that the lack of access to credit has also

contributed to the reduced number of car purchases since mid-2008.70 This suggests that better

financial market conditions could provide momentum to vehicle sales. Since the financial crisis has

occurred, central banks dropped their interest rates to historically low levels, in order to keep

financing costs and yields low and boost economy. People’s Bank of China (PBC) has continuously

decreased its interest rate from around 7.5 per cent pre-crisis level to 4.35 per cent in October 2015.

The US Federal Reserve System (Fed) changed its rate from 4.5 per cent in October 2007 to 0.25 per

cent in December 2008. Since December 2015, the Fed rate has increased to 0.5 per cent, indicating

that the U.S. is getting over the crisis. The lowest interest rate amongst Tesla’s main markets is

currently provided by the European Central Bank (ECB). The ECB had a historical interest rate of 4

per cent before the crisis, but it was changed to 0 per cent as of March 2016. The ECB has also cut

the deposit rate facility to minus 0.4 per cent, meaning it is now more costly for banks to hold cash

than lend it out to customers. 71 Improved financial market conditions should have a positive effect

on vehicles sales in the future.

3.1.2 .4 COM MOD ITY P RI CES

3.1 .2 .4 .1 C R U D E O I L

The price of crude oil has significant influence over the automotive industry. Fluctuations in crude

oil prices affect the cost of production, as well as customer demand. If gasoline prices are high,

owning an ICE car can be costly that might encourages people to seek another means of

transportation, and vice versa.

70 OECD Economic Outlook, Vol. 2009 Issue 2, “The automobile industry in and beyond the crisis” 71 Global Rates (07.01.2016), “ECB refi rate - European Central Bank’s interest rate”


41

Source: Compiled by author / MacroTrends / World Bank

Crude oil prices were characterized by high volatility over the years. The financial crisis had a

negative effect, causing a steep drop in the value of oil. Crude oil prices, however, have relatively

quickly normalized and reached pre-crisis levels. Over the next few years, prices remained high,

which made more expensive techniques such as deep water drilling and fracking pay off. As a result,

the U.S. has reached its highest production level for decades that weakened domestic demand.

Demand for crude oil has also dropped in China due to economic slowdown. Instead of reducing

global supply, the Organization of Petroleum Exporting Countries (OPEC), which accounts for about

42 per cent of world supply, engaged in a price war to maintain market shares. In addition, Iran

started to export oil after economic sanctions had been lifted due to compliance with nuclear deal.

Weak demand, coupled with increased production led to oversupply. As a result, crude oil prices have

dropped to historically low levels.72

Price of a barrel of oil went as low as USD 26.05 in February 2016, a more than 70 per cent decrease

from the 2014 level. Nonetheless, the World Bank has raised its 2016 forecast for crude oil prices

from USD 37 per barrel to USD 41 a barrel.73 In its latest prognosis, crude oil prices are expected to

reach USD 58.8 by 2020, which is still far from pre-crisis levels. This, however, might be a fairly

72 Bloomberg (02.06.2016), “Oil prices” 73 World Bank. Commodity Markets Outlook; 2015 Q4, 2016 Q1 & Q2

0

20

40

60

80

100

120

Historical & forecasted crude oil prices, $/bbl (nominal)

CAGR = -10,30% CAGR = 9.43%


42

modest forecast as a barrel of oil is already priced above USD 44.74 Oil prices have started to rise

again due to production decline in the U.S., Canadian wildfire that required to shut down pipelines,

and political factions in Libya.75

In overall, the price of crude oil is currently low but it is expected to rise during the upcoming years.

Nevertheless, it most likely will not reach pre-crisis levels by the end of the decade. We should bear

in mind that crude oil prices are sensitive to environmental, economic and political factors. Future oil

prices, therefore, largely depend on changes in these factors.

3.1.2 .4 .2 RAW M ATER IA LS

According to Market Realist, about 47 per cent of vehicles’ costs come from raw material, making it

the biggest cost driver in the auto industry.76 Tesla mainly uses aluminium, copper and nickel to

produce its vehicles.77 Although aluminium is more expensive, it is much lighter than steel and has

the same strength. The body and chassis of Tesla’s vehicles, therefore, are mainly made of this

material to improve range.78 Moreover, Tesla uses nickel, cobalt and aluminium in its battery cells.

Fluctuation in the prices of these commodities, therefore, directly affects manufacturing costs.

Source: Compiled by author / MacroTrends / World Bank

74 Investing.com (05.05.2016), “Crude oil historical data” 75 The Week (05.05.2016), “Oil prices boosted by Canadian wildfire and Libyan unrest” 76 Market Realist (05.02.2015), “Raw materials – the biggest cost driver in the auto industry” 77 Tesla Annual Report (2015), p. 10 78 Tesla Annual Report (2015), p.7

0

5000

10000

15000

20000

25000

30000

35000

40000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Historical and forecasted raw material prices, $/mt

Aluminium Copper Nickel


43

Prices of raw materials have significantly dropped since the financial crisis. The World Bank’s latest

commodity markets outlook, however, forecasts an increase in the value of these commodities. From

2016 to 2020, prices of copper, aluminium and nickel are expected to rise by 16, 17 and 36 per cent,

respectively. Due to competitive pressure, however, automotive companies can hardly pass cost

increase to customers. Consequently, rising raw material prices might influence Tesla’s profit

margins in the future.

L ITH IU M

There are many possible uses of lithium, which include glass, lubricants and pharmaceuticals. With

the spread of portable technological devices, lithium use in batteries have increased from 26 per cent

in 2009 to 39 per cent in 2015. Global lithium demand is expected to skyrocket with the advent of

electric vehicles that mainly use lithium-ion batteries.79 Goldman Sachs already calls lithium the ‘new

gasoline’, while The Economist considers it ‘the world’s hottest commodity’.80,81

Tesla is using lithium-ion cells in its vehicle powertrain systems and stationary energy storage

products. Changes in the price of lithium, therefore, can affect Tesla’s cost of manufacturing.

Gigafactory is currently under construction to supply enough battery cells for increasing future

demand of Tesla products. According to Elon Musk, the company would need to absorb today’s entire

global lithium ion production to reach full capacity. Due to increasing demand, the average price of

lithium has jumped by 47 per cent in the first quarter of 2016 and expected to further increase in the

future.82 Majority of global lithium production is in the hand of three companies, thereby creating an

oligopolistic environment that can lead to further price pressure.

3.1.3 SOCIAL FACTOR S

Environmental awareness has significantly increased over the past decades. According to researches,

two-thirds of consumers intentionally avoid certain brands due to environmental concerns. Today,

people feel greater responsibility to take action in order to preserve the environment.83

In addition, studies have found that status motives increased desirability of green products, especially

when such products cost more than their non-green counterparts. Choosing a more expensive product

79 Battery University (01.04.2016), “BU-308: Availability of Lithium” 80 Goldman Sachs (2015), “Global Investment Research”, p. 16 81 The Economist (16.01.2016), “An increasingly precious metal” 82 The Wall Street Journal (05.05.2016), “How Tesla Is Shaking Up Metals Markets” 83 Huffpost Business (09.10.2015), “Environmental Concern Empowers the People”


44

that is environmental-friendly signals that the person has enough wealth to sacrifice resources to act

prosocial. Prosocial behaviour and resources are associated with an individual’s status in a group.

Choosing a more expensive green car, therefore, can lead to social reputation and good reputation is

more valuable than money (Vladas, 2010).

3.1.4 TECHNOLOGICAL FACTOR S

Today, we live in a rapidly changing environment in terms of technology. Technology advancement

highly formulated the automotive industry over the past few years. Development of electric and

hybrid vehicles, computerized control systems with autopilot functions, as well as automatic parking

systems became available, and more innovations can be expected in the future. Computer aided

design and crash test simulations leads to more variety and improved safety of future vehicles.

Range anxiety and battery costs, however, still limit consumer adoption of electric vehicles. Although

Tesla offers the highest range electric vehicles on the market with charging flexibility, consumers

still fear that they will run out of energy.84 While Tesla is continuously improving the range of its

vehicles, it is also building a network of charging stations to solve range problems that will be further

discussed later. The cost of battery largely determines the cost of the final product.

Source: Compiled by author / Goldman Sachs

Tesla has reached significant battery cost reduction over the years. Even though the company does

not publish exact numbers, it is estimated that its first model had a battery cost close to USD 600 per

kilowatt-hour. Tesla’s current battery cost is somewhere between USD 180 and USD 250 per


0

100

200

300

400

500

600

2008: Roadster 2010: Roadster(2nd Gen)

2012: Model S 2017: Gen III 2020: Gigafactory

Battery costs, $/kWh


45

kilowatt-hour. With operations in the Gigafactory is about to start in 2017, it is assumed that the new

model will have a battery cost below USD 200 per kilowatt-hour. Once the Gigafactory reaches full

capacity in 2020, battery prices are expected to drop to nearly USD 100 per kilowatt-hour thanks to

higher economies of scale. According to industry experts, once battery costs reach the USD 100 mark,

electric vehicles will be cost-competitive with their gasoline-powered counterparts.85

3.1.5 CONCLUSION OF EXTERNA L ANALYSIS

Future performance of Tesla Motors depends on a number of external factors. Automotive is a

cyclical industry, hence its performance largely depends on future business cycles. A moderate global

economic growth is forecasted, with the highest growth coming from China. Nonetheless, growth in

China is expected to slow down that generates concerns in the automotive industry, as China has the

biggest auto market. Given the industry’s cyclical nature, moderate economic growth will most likely

be followed by a moderate growth in vehicle sales. It is, however, noteworthy that global vehicle

sales growth fell below global GDP growth that can be a warning sign of future economic slowdown.

In order to boost economy, central banks have decreased interest rates and some of them have even

imposed negative deposit rates to encourage banks to lend money. Improved financial market

conditions, i.e. easier access to credit, will probably have a positive effect on vehicle sales.

Governments also play a major role in Tesla’s future performance. Higher government pressure to

improve fuel economy and lower GHG emission pushes automakers to shift towards more eco-

friendly cars. In addition, government incentives encourage both manufacturers and customers to go

green. On the one hand, it is good news for Tesla because demand for EVs rises. On the other hand,

this will increase the level of competition in the EV segment. Although governments around the world

offer incentives for purchasing environmental-friendly vehicles, most of these incentives will phase

out by 2020. Unless further incentives will be provided, the price of green vehicles will increase as

current incentives cease. Moreover, Tesla is required to fight legal battles for the right to sell its

vehicles in its domestic market. Although fighting legal battles is capital and time consuming, it is

necessary for Tesla to be able to fully exploit U.S. potentials. If the company loses in court, it will be

banned from marketing its products, hence winning the right to directly sell to customers is one of

Tesla’s biggest challenges.

85 Clean Technica (05.09.214), “Tesla’s Gigafactory May Hit $100/kWh Holy Grail Of EV Batteries”


46

Government efforts seem to pay off, as studies show that environmental awareness has increased over

the years. Customers consciously avoid certain brands due to environmental concerns and choose

green products over non-green products, especially when green products are more expensive. The

explanation is that sacrificing resources for the common good, i.e. protecting the environment, is

associated with prosocial behaviour, which improves social status. Ceasing government incentives,

therefore, might not influence Tesla’s future performance badly. In fact, higher EV prices might

provide higher social status for customers. In general, Tesla will benefit from this green trend in the

future.

By entering the mass-market with the new model, however, Tesla will have a different customer base

that is less motivated by social status and more sensitive to prices. Factors that influence the cost of

final product, therefore, will have greater significance in Tesla’s future success. Such factor is the

future price of commodities. Crude oil price has reached historically low levels due to oversupply

that was caused by lower demand and OPEC’s price war to maintain market share. Although crude

oil price has started to rise again, it is expected to remain below the pre-crisis levels until the end of

the decade. Low crude oil prices mean lower production cost for most companies. Tesla, however,

increasingly rely on renewable energy, thus mainly its suppliers can benefit from cheaper oil prices.

Current low oil prices reduce the competitiveness of EVs compared to ICE cars. Higher future oil

prices, on the other hand, put EV producers in a better competitive position. The price of other

commodities, such as aluminium, copper and nickel, nonetheless, has direct effect on Tesla’s

manufacturing costs. Prices of these commodities are expected to rise that can lead to higher raw

material costs and lower profit margins.

Technological development, however, can lead to advancements in production efficiency that can

offset rise in raw material prices. Tesla has already achieved significant reductions in battery costs

that largely contributes to the final cost of the product. According to forecasts, once the Gigafactory

operates at full capacity, Tesla has a battery price close to 100 per kilowatt-hour, which is the

theoretical level at which EVs are as cost-competitive as ICE cars. In overall, technological

advancements lead to better performing vehicles and improved battery costs that enables Tesla to

better compete in the future.


47

3.2 INDUSTRY ANALYSIS: PORTER’S FIVE FORCES ANALYSIS

The attractiveness of an industry is defined by the chance of earning returns that exceed the cost of

capital. Amongst scholars it is agreed that higher level of competition lowers the possibility of

obtaining acceptable returns.86 Porter’s five forces analysis is a useful tool to highlight the different

factors affecting the competition in a given industry, hence painting a better picture of the company’s

earnings potentials. According to Porter, the five forces that shape any industry’s attractiveness are

the following: threat of new entrants, threat of substitutes, bargaining power of suppliers, bargaining

power of customers and the intensity of existing competitive rivalry amongst industry players. The

following figure illustrates how these forces are linked to each.

3.2.1 THREAT OF NEW ENTRANTS

If an industry promises high profitability, more and more company might decide to explore the

opportunity of good earnings. The ultimate aim of new entrants is to gain market share, which

indirectly affects existing companies’ market shares and profitability already operating in the

industry. We can determine the threat of new entrants by looking at the different factors that limit the

ability to enter the industry, also known as the barriers to entry. When analysing these barriers we

should distinguish between the traditional ICE and the emerging EV market.

In general, the automotive industry is characterized by high capital requirements. New entrants should

invest a considerable amount of money in raw materials, production facilities and workforce. The

average capital expenditure (CAPEX) spent by the ten biggest automobile OMEs exceeded USD 6.3

billion in 2014, which is a slight increase from the previous year’s USD 6.1 billion. Tesla Motors’



48

cash flows from investing activities, which primarily related to CAPEX, were USD 264.2 million,

USD 969.9 million and USD 1630 million in 2013, 2014 and 2015. Although Tesla spends far less

money on CAPEX compared to the biggest industry players, we can clearly see an upward pattern. It

is already clear that high initial investments are needed to be able to start a business within this

industry. By comparing CAPEX to sales ratios, however, we can have an idea of the required level

of income to be reinvested in order to keep a company in business. In this sense Tesla Motors by far

exceeds the well-positioned industry players. It reinvests a lot higher percentage of its sales revenues

than any of the ten biggest automobile OMEs (see Appendix 4 and 5). It is because Tesla is considered

to be a new entrant and has to build up everything from the ground.

Technological complexity is another barrier to entry. It takes a certain level of expertise and thousands

of components to build a car. Companies are not only challenged to find and retain workforce with

the right skills, but to keep up with the latest technological innovations. Innovations are driven by

both competitive and political pressure. New models are required to comply with higher government

standards in terms of safety and green-house gas emission level. In order to keep the prices low and

stay competitive in this capital-intensive environment, manufacturers must be able to achieve

economies of scale. Automobile producers should reach mass production, thereby making cars

affordable for more customers. It is usually hard for companies with limited resources to achieve that.

Companies already operating in the industry have their strong distribution networks. It can be difficult

for new entrants to establish their own distribution channels as there are a limited number of

dealerships available. One solution is to follow Tesla’s example who has its company-owned stores,

thereby cutting out the middle guy and directly selling to end-users. Nevertheless, even this business

model has some challenges, as the company faces lawsuits brought by dealer associations, whose aim

is to prohibit to cut out the middle guy.87

Although companies who start from scratch would face huge challenges when entering the industry,

it is relatively easy for well-established companies to enter the EV segment, in which Tesla is

competing, as they have the required capital and economies of scale. Therefore, we should be careful

when measuring the threat of new entrants. On the one hand, the chance of a new brand entering the

market is considerably low. On the other hand, industry leaders who are facing an increasing pressure

to go green can relatively easily enter the EV segment. BMW, Daimler, Nissan, Fiat, Ford and

Mitsubishi are already producing electric vehicles. In addition, Porsche, Lexus, Audi, Volkswagen



49

and Volvo are also working on their own electricity powered cars.88 Although currently none of these

manufacturers have models with attributions similar to Tesla, they put increasing pressure on the

Silicon Valley-based company.

I conclude that the threat of new entrants currently range from low to moderate but it will most likely

increase in the long run.

3.2.2 THREAT OF SUBSTITUTES

There are several other forms of transportation available than using a car, such bicycles, motorcycles,

buses, trains and airplanes. Nonetheless, none of these alternatives offers the flexibility and

convenience of a car. Geographical location of potential customers, however, can affect the preferred

means of transportation. In densely populated areas public transportation might perceived as a better

solution, while in rural areas, where this service is less available, people may prefer to own a car.

According to the American Public Transportation Association, public transit use has grown more than

population or highway travel in the U.S. during the last decade, indicating that an increasing rate of

people choose some kind of public transportation.89 As EVs are currently more suitable for short

distance travels, given their relatively short range compared to ICE, public transportation is might

perceived as more of a threat for EVs than as it is for traditional cars. For those who buy an electric

car for its price efficiency, public transportation is a potential substitute. However, Tesla’s customers

represent the premium segment who choose the vehicle for its superior features, hence they are less

motivated by cheaper transit.

When measuring the threat of substitutes of EVs, we should also consider ICE vehicles, hybrids and

plug-in hybrids as viable alternatives. As these types of vehicles offer higher range than solely electric

powered cars, they are more of a threat to EVs than any other types of transportation. In terms of

environmental-friendliness, however, none of them are as effective as a zero emission electric vehicle,

which is why they might not serve as substitutes for those who make their purchase due to

environmental awareness. Considering that new technologies are developed every day, however, we

can expect a slight rise in the threat of substitutes.

88 Tesla Annual Report (2015), p. 12 89 2015 Public Transportation Fact Book (2015), p. 11


50

I conclude that the threat of substitutes in traditional automotive sector is low, while it is moderate

in the EV segment. As new technologies are developed daily, a slight increase in substitute threat can

be expected.

3.2.3 BARGAINING POWER OF SUPPLIERS

As it was mentioned above, automobiles require thousands of different parts. It was not uncommon

amongst automakers to have thousands of suppliers for these components. Nonetheless, everything

has changed when the latest financial crisis hit the automotive industry and world motor vehicle

production has fallen in 2008 and 2009 (see Appendix 6). Original equipment manufacturers’

(OEMs), such as Ford Motors, respond for shrinking demand was to reduce the number of suppliers

to cut production cost.90 As a result, significance of the remaining suppliers have increased, which

put them in a better bargaining position. During the financial crisis, struggling key industry suppliers

were not only less willing to reduce prices but insisted to increase margins to be able to manage high

fixed cost and continue operation. Ford Motors, for instance, had to fulfil its key suppliers’ claims to

ensure uninterrupted production.91

Since automobile companies use a smaller number of suppliers than before, they are more reliant on

these suppliers. The figure below depicts that the proportion of suppliers’ value addition in

automobile production has increased from 56 per cent in 1985 to more than 80 per cent in 2015. It

suggests that OEMs are turning from manufacturers to more of assemblers, as most of the vehicle

parts are produced by suppliers. OEMs are more focused on what they do best, i.e. vehicle design,

marketing and distribution.92

90 Bloomberg (21.10.2013), “Ford Plans to Reduce Number of Suppliers by 40%” 91 Ford Annual Report (2015), p. 14 92 Bain & Company (1999), “The dawn of the mega-supplier”, p. 5


51

Source: Compiled by author / Statista

More concentrated supplier base, coupled with higher value addition leads to the formation of mega-

suppliers. Of the world’s 100 largest global OEM parts suppliers, the top twenty accounted for more

than half of total global OEM automotive part sales revenues in 2014.93 Ford, who acquires about 80

percent of its parts from the 100 biggest suppliers and about 60 percent from the top 65, is a great

example of this trend.94 As fewer but bigger companies continue to supply automakers, the balance

of power slowly shifts from OEMs to suppliers.

Moreover, the majority of lithium production is controlled by only three companies. This creates an

oligopolistic situation that put lithium suppliers in a better bargaining position.

From suppliers’ perspective, however, automakers represent powerful customers. The automotive

industry is considered to be an oligopoly, meaning only a few big company serves the market needs,

hence only a few company buys up all the automotive parts. As there is a limited number of customer,

i.e. automakers, they are in a position to influence supplier margin to a certain extent.

While Tesla uses multiple sources for some of its components, many of them are still purchased from

a single supplier.95 This creates a monopolistic situation for single-source suppliers that provides

them higher bargaining power.

I conclude that the bargaining power of suppliers is moderate but rising.

93 Automotive News (2015), “Top Suppliers” 94 Bloomberg (21.10.2013), “Ford Plans to Reduce Number of Suppliers by 40%” 95 Tesla Annual Report (2015), p. 9

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1985 1990 1995 2000 2005 2010 2015

Proportion of Supplier Value Addition in Automobile Production


52

3.2.4 BARGAINING POWER OF CUSTOMERS

While other automotive companies use the traditional distribution channels, relying on dealerships to

market their products, Tesla sells directly to customers through a network of company-owned stores.96

The relevance of this type of distribution model is that Tesla sells to individuals who have little

influence over the price of that one or two cars they are about to buy, while companies using the

traditional franchised distribution model should deal with dealerships who buy a higher number of

cars, hence they have higher buying power than individuals.

Even though individual buyers can hardly negotiation prices, they can easily alter their purchase

because of the wide range of brands available on the market and the low switching cost associated

with choosing from these brands. Due to government regulations and intensifying competition,

manufacturers are continually challenged to introduce higher quality products with lower prices.

These products start to offer similar features, as more and more components are sourced from the

same mega-suppliers. As future models are becoming increasingly similar, price plays a more

important buying factor. Price sensitive customers may switch to another model, if it offers the same

specifications at a lower price. Customers in the premium segment, however, are less price-sensitive,

as they are more driven by the perception that certain brands offer superior features. As a result,

OEMs put a lot of effort to achieve higher brand recognition, which in return would weaken the

bargaining power of customers. According to Advertising Age, automotive industry will spend over

USD 44 billion on advertising in 2016, which is the highest amount amongst all industries.97 Although

Tesla operates in the premium segment, it has mostly relied on media coverage and word of mouth

advertising.98 This strategy had worked so well that customers have already stood in line to put the

USD 1000 deposit down for Model 3 before even seeing it or knowing its final price.99 While the

lower price is most certainly a positive attribution of the new model, it seems that Tesla fans are so

fascinated by the brand that they do not even try to negotiate on price. Nonetheless, as Tesla moves

from the premium segment to mass market, price sensitivity of customers will most likely rise.

I conclude that the bargaining power of customers is currently low but probably rises as Tesla enters

the mass market.

96 Tesla Annual Report (2015), p. 7 97 Advertising Age (11.06.2015), “Global Ad Spending Will Be Up an Average 4.2% Next Year” 98 Tesla Annual Report (2015), p. 8 99 International Business Times (31.03.2016), “Tesla Model 3 launch”


53

3.2.5 INTENSITY OF EXISTING RIVALRY

According to Tesla, it competes both with traditional internal combustion automobiles and alternative

fuel vehicles, principally electricity-powered models.100 Therefore, we should analyse both segments

when determining the level of rivalry. There are a number of factors influencing the level of

competition in a given industry. As a result of globalization, competition is no longer limited to

domestic markets but automakers should compete with each other on a global scale. The number of

competing firms have increased but high exit barriers prevent existing companies to leave the

industry. Since there is a little chance that the number of car manufacturers declines, the rate of

existing rivalry is unlikely to decay either.

The power of the five forces typically varies with the stages of the industry life cycle. Introduction

phase is characterized by high innovation costs, low profit and few players. Growth phase experiences

growth in sales and profit margin while the level of competition and buying power is still low.101 I

consider the EV segment to currently be in its introduction stage as different models and the required

infrastructure are both under development. Nevertheless, automakers have already invested a lot of

money in the new technology. With government subsidies and rising environmental concerns,

popularity of green cars is likely to rise. Thus, I assume that the EV segment reaches its growth phase

in the not too distant future. According to KPMG’s report, less than one in twenty vehicles produced

will be equipped with electrified powertrains by 2020. At first it does not seem much, but it is a big

leap when considering that five years ago this rate was less than one in sixty cars.102 The traditional

ICE segment, however, has reached its maturity stage, in which companies face with average industry

growth, more powerful buyers due to lower switching cost, and lower margins as a result of higher

competition for market share. Intense rivalry in the traditional segment and government regulations

encourage automakers to enter the alternative fuel market. Consequently, I expect increased

competition in this segment as well in the long run.

We can quantify the intensity of existing rivalry by calculating the market concentration ratio. It

indicates the size of firms in relation to their industry and the level of competition among them. There

are a number of ways to calculate this ratio but the most commonly accepted measure is the

Herfindahl-Hirschman Index (HHI). The HHI is calculated by squaring the market share of each firm

competing in the market and then summing the resulting numbers. The HHI index was approximately

100 Tesla Annual Report (2015), p. 12 101 Johnson, G. et al. (2011), Exploring Strategy,9th edition, p. 65 102 KPMG (2015), “KPMG`s Global Automotive Executive Survey”, p. 18


54

644 and 704 in 2009 and 2014 (see Appendix 7). According to the U.S. Department of Justice, this

classifies the market as concentrated.103

Although higher HHI in 2014 compared to 2009 indicates decrease in competition, most of the biggest

auto manufacturer are more powerful than before, as they have gained market share from the rest of

the competing firms. The figure below compares passenger car production in 2009 and 2014.


By analysing these two pie charts, we can see that OEMs’ market shares have rearranged during the

years. Although the composition of the top ten automotive producers remaind the same, their order

has changed. Volkswagen, Toyota, Hyundai, Honda and Nissan have all gained market share, but the

rest of the companies in the peer group lost market presence. The share of ‘Other’ manufacturers has

also declined. While the top five passenger car manufacturer provided less than 47,5 percent of global

production in 2009, they supplied more than half of total production in 2014.

I conclude that the intensity of existing rivalry is high in the traditional ICE segment. It is currently

between low and moderate in the EV segment but most likely intensifies in the future.

3.2.6 COMPERATIVE INDUSTRY STRUCTURE ANALYSIS

Given the fact that industry life cycle affects the power of five forces, it is required to make industry

structure analyis dynamic. It can be done by comparing the five forces over time in a radar chart that

provides a more refined summery of this chapter. The figure below illustrates the power of each of

the five forces over time.

103 The United States Department of Justice (19.08.2010), “Horizontal Merger Guidelines”

Toyota; 12,04%

Volkswagen; 11,56%

G.M.; 9,79%

Hyundai; 8,27%

Honda; 5,84%

Ford; 5,78%PSA; 5,42%

Nissan; 4,66%

Suzuki; 4,12%

Renault; 4,00%

Other; 28,52%

PASSENGER CAR PRODUCTION 2009

Volkswagen; 13,55%

Toyota; 12,19%

Hyundai; 10,59%

G.M.; 9,22%Honda; 6,21%

Nissan; 5,94%

Ford; 4,48%

Suzuki; 3,53%

PSA; 3,50%

Renault; 3,33%

Other; 27,46%

PASSENGER CAR PRODUCTION 2014


55

Source: Compiled by author (see Appendix 8)

I quantified the different levels of power to make a graphic illustration of the five forces possible. I

ranked each of the forces from one to three, one refering to high level of power and three meaning

low power. The higher the power of a force the closer its value to the centre. Accordingly, the total

area enclosed by the line is smaller when the foreces are high and bigger when they are low. The

larger the enclosed area, the more attractive is the industry and the greater is the profit potential.

The large enclosed area in Time 0 suggests that it is an attractive industry to invest in now. The early

stage of the industry life cyle in the EV segment, however, requires us to look further. Based on the

above analysis, I predict some increase in substitute threat due to continuous technological

advancement within the industry. Supplier power might enhance with the stregthening of mega-

suppliers. Buyer power will most likely rise after Tesla enters the mass market, where it has to deal

with more price sensitive customers. Increasing environmental pressure encourages existing

automakers to go green. As a result, entry threat is expected to heighten. If more OEM enters the

alternative fuel segment, intensity of existing rivalry probably goes up. In overall, the smaller

enclosed area in Time + 5 indicates less attractive market conditions than it is in Time 0. These values,

however, are used for illustration purposes only.

3.3 INTERNAL ANALYSIS: VALUE CHAIN ANALYSIS & VRIO

The ultimate goal of any organization is to create value for which customers are willing to pay. Value

creation occurs when the benefits of products and services being produced are higher than the cost of

Rivalry

Substitute threat

Buyer powerSupplier power

Entry threat

Comperative Industry Structure Analysis

Time 0

Time + 5


56

production. Companies that create the most value usually outperform others.104 It is therefore vital to

realise which activities the company undertakes are relevant in creating value and which ones are not.

In 1985, Michael Porter introduced the concept of value chain. It is a series of interdependent

activities that add value to a product or service during each step of production. According to Porter,

every business conducts primary and support activities that fall into nine generic categories as shown

below. 105

Source: Compiled by author

3.3.1 SUPPORT ACTIVITIES

Support activities supply the required infrastructure that makes primary activities possible. In the

above diagram, the dotted lines show that each support activity can play a role in each primary

activity. If well-managed, therefore, support activities can help to improve efficiency of primary

activities.

3.3.1 .1 F I RM INF RAST R UCTU RE

Tesla has adopted a flat organizational structure that carries many advantages.106 It is cost efficient

because fewer manager layers means less salary-related expenses. Tesla hires less employees, hence

104 Kim, S. et al. (2006), Competing Values Leadership, p. 21 105 Harvard Business Review (1985), “How Information Gives You Competitive Advantage” 106 Tesla Motors (28.04.2016), “Careers”


57

it can afford better pay. Even though Tesla is a small player in the automotive industry, it offers higher

salaries for its engineers than its giant competitors (see Appendix 9). Thereby, it ensures that the best

minds are working for the company.

Smaller management team leads to faster decision making because fewer people need to be consulted

about a decision. It allows clear communication, as information is less likely to be distorted between

the executive and the staff. Less supervision is required, thus, managers can focus on reaching the

company’s objectives instead of spending time on monitoring.

Besides having an organizational structure that boosts productivity and creativity, Tesla also has Elon

Musk. He has the required expertise, leadership and management skills to build a company that is

able to achieve Tesla’s objectives.

3.3.1 .2 HUM AN RESO UR CE M ANAGEMENT

Tesla is committed to hiring and developing top talent from across the world for any given

discipline.107 Finding employees with the right skills is not an easy task, which is why the company

puts a lot of effort in retaining them. Tesla not only offers high salaries, but it has adopted the 2010

Equity Incentive Plan that provides for the granting of stock options, restricted stock units (RSU) and

stock purchase rights to employees.108 Thus, Tesla aligns employee interests with company goals.

The number of people employed by the company has more than doubled from 5,859 in 2013 to 13,058

in 2015.109 Tesla, therefore, decided to outsource its human resource related tasks to be able to keep

up with growing demand and manage global expansion.110 Outsourcing helps the company focus its

attention on its core business, which is developing and producing electric-powered vehicles. By

relying on an external partner, who understands the local labour laws, Tesla can comply with

employer obligations and provide competitive benefits to employ the most talented workforce in each

country it is represented, while preserving its company culture.

3.3.1 .3 TE CHN OLOGY DEVELOPMENT

Given the fact that the EV segment is still in its infancy, most companies are still inexperienced with

new technologies. Tesla, being a ground-breaking company in the EV market, develops and utilizes

107 Tesla Motors (28.04.2016), “Careers” 108 Tesla Annual Report (2015), p. 66 109 Tesla Annual Report (2013 & 2015), pp. 22, 12 110 Radius (28.04.2016), “Tesla Motors: Achieving Excellence and Innovation Overseas”


58

state-of-the-art technologies.111 Employing the latest technologies helps Tesla creating products that

no one has ever seen before, thereby staying ahead of its competitors. Tesla equips and continuously

improves all of its models with autopilot system. It includes auto-steering, traffic aware cruise control,

lane changing, automated parking, driver warning systems and automated braking functions.112 It

provides convenient ride with increased safety, hence reducing the chance of future accidents. This

technology is so promising that other automakers, such as BMW, are also working on their own

autonomous electric vehicles.113 The on-board system, furthermore, allows Tesla to diagnose and

solve several problems without ever seeing the vehicle.114 This makes after-sales service a lot cheaper

and faster.

Having the latest technologies requires an extensive amount of investments in research and

development. Even though Tesla earns only a fragment of its biggest competitors’ sales revenues, it

reinvests a lot higher percentage of its earnings on research and development (R&D). While the R&D

to Sales ratio ranged between four to five per cent for the majority of top automotive OEMs, it has

increased to more than nineteen per cent for Tesla Motors (see Appendix 10). Tesla’s high R&D rates

do not fit in the auto industry, which is why there is an active debate on whether Tesla qualifies as an

auto company or a tech company.115 In general, companies spend on R&D because they want to

develop new products or processes that lead to future growth. Following this argument, we can

conclude that companies that spend the highest rate of its earnings on R&D will experience the highest

future growth.

Tesla protects its intellectual property rights by using patents. This would prevent competitors with

strong financial backgrounds to copy Tesla’s products. Nevertheless, Tesla has announced a patent

policy in which it irrevocably promised that it will not initiate lawsuit against any party for violating

its patents for long as such party is acting in good faith. On the one hand, the company does this to

remain faithful to its mission, which is accelerating the advent of sustainable transport. On the other

hand, it hopes that the technology platform will more rapidly evolve after sharing its patents with the

world, from which Tesla itself can benefit as well.116

111 Tesla Annual Report (2015), p. 5 112 Tesla Annual Report (2015), p. 7 113 Computerworld (16.03.2016), “BMW: Our future is electric and autonomous cars” 114 Tesla Annual Report (2015), p. 8 115 The Motley Fool (11.04.2016), “The Most Compelling Argument for How Tesla Motors Is a Tech Company” 116 Tesla Motors (12.06.2014), “All Our Patent Are Belong To You”


59

3.3.1 .4 PRO CU REMENT

Tesla has more than 350 suppliers worldwide who provide over 3,000 parts to build a Tesla model.

In order to prevent lag in production, Tesla has developed close relationship with its key suppliers.

Moreover, it has established a partnership with Panasonic who would invest in production equipment

that will be used in the Gigafactory to supply Tesla with battery cells.117 This cooperation is essential

to set up the Gigafactory, which will increase manufacturing capacity and make Model 3 production

possible.

3.3.2 PRIMARY ACTIVITIES

Primary activities are concerned with the creation of a product or service, its marketing and delivery

to customers, and its maintenance and servicing after sale. That is why, primary activities are directly

related to value creation. Describing Tesla’s primary activities, therefore, helps determining its core

competences.

3.3.2 .1 INBOU ND LO GIS TICS

Since I am using only publicly available data, it is difficult to determine how efficient Tesla is in

handling inputs. However, we know that Tesla maintains a good relationship with its key suppliers.

This is necessary, in order to have a disruption-free production. Another way of securing smooth

production is to produce the most important components in-house. Tesla has the required in-house

capabilities to design and engineer electric vehicles and electric vehicle components and systems. In

addition, the company carries only a low level of inventory in its galleries.118 Keeping inventory level

at minimum helps the company save space and money by using the funds, otherwise spent on

maintenance, for other uses. Reduced inventory cost allows more competitive pricing hence higher

profit margins.

3.3.2 .2 OPER ATION S

As it was mentioned above, Tesla designs and produces its most important parts in-house. It

manufactures various aluminium components at its facility in Lathrop, California. But the final

assembly takes place at the Tesla Factory, in Fremont, California. Tesla has achieved high level of

vertical integration here. Some areas of the factory have been designed to serve multiple products,

117 Tesla Annual Report (2015), p. 9 118 Tesla Annual Report (2015), p. 7


60

hence providing high level of flexibility. It allows faster production, while maintaining Tesla’s high

quality standards.

The company has a third manufacturing facility in Tilburg, Netherlands. It manufactures, quality

checks and distributes products to customers in all markets outside of the United States. The facility

in Tilburg plays an important role in administration, and customer service in non-US markets. This

provides better corporate oversight that leads to more efficient globalization.119

Additionally, Tesla is building its own battery manufacturing facility, the Tesla Gigafactory, outside

of Reno, Nevada. It will bring battery material, cell and battery pack production under one roof. The

company expects to begin cell production in 2017 and reach full capacity by 2020, when it is projected

to manufacture more lithium ion batteries annually than the total world output in 2013. Using high

level of integration and economies of scale, Tesla expects to reduce the cost of battery packs by more

than 30 per cent.120 This is vital in order to be able to bring Model 3 to mass market.

Moreover, Tesla considers to set up a manufacturing facility with a local partner in China in order to

avoid high import duties and have access to more EV incentives that are mostly offered for locally

produced vehicles. If Tesla can establish this partnership, it will be able to better compete in its second

largest market.121

Tesla has core competences in computer aided design and crash test simulations that is expected to

reduce product development time for new models. These core competences have probably helped

Tesla earning the highest safety rates by the NHTSA. Moreover, Tesla has expertise in lightweight

materials that is essential for building long-range vehicles.122

3.3.2 .3 OUTBOU ND LOGI STICS

All vehicles produced for the US market are manufactured and distributed by the Tesla Factory, while

products for the rest of the world are supported by the Tilburg facility. The facility in the Netherlands

has strategic positioning and plays an important role in reducing order lead time in Europe. Finalizing

a partnership in China would further reduce lead time in the world’s biggest auto market and

contribute to faster delivery. Due to lack of internal sources, it is difficult to determine how efficient

119 Tesla Annual Report (2015), p. 9 120 Tesla Motors (02.05.2016), “Tesla Gigafactory” 121 Electrek (27.03.2016), “Tesla is reportedly considering a factory location in Suzhou” 122 Tesla Annual Report (2015), p.7


61

Tesla is in delivering vehicles to customers after placing their orders. Nonetheless, those who order

the new model can expect long delivery time that might alter their purchase.123

3.3.2 .4 M ARKETING & SALES

According to Tesla, it spends a relatively low amount of money on traditional advertising. Instead, it

mostly relies on word of mouth and media coverage to drive its sales.124 Tesla Roadster and Model

S have appeared in popular movies and series such as Suits, Iron Man or Fifty Shades of Grey.125 In

these movies, Tesla owners represented forward looking and open minded individuals who like

premium, state-of-the-art vehicles that possesses a “coolness-factor”. This kind of media coverage

has a powerful impact on the popularity and fashionable image of Tesla products.

As it was mentioned in the five forces analysis, Tesla sells its vehicles directly to customers using a

network of company-owned stores. Tesla uses highly visible, premium outlets to reach its vendee. As

the vast majority of Tesla’s vehicles is customized, these galleries carry very limited inventory that

used only to introduce products to potential buyers. Tesla offers customers to place their order through

using the company’s online platform, where the vehicle can be tailored to the needs of the client.

From value creation perspective, Tesla creates value by controlling the entire buying experience,

thereby differentiating itself from competitors who use dealerships to sell their products. Forward

integration helps Tesla to further strengthen its brand and better control costs of inventory.

3.3.2 .5 SER VI CES

The company puts great emphasis on after-sales service. It had 118 company-owned service centres

operational by the end of 2015 and is planning to add more in several markets worldwide. These

service centres enables technicians to work closely with engineers and research and development

teams that leads to faster problem solving. In certain areas for additional charge, customers can also

choose the service of Tesla Ranger mobile technicians that does not require a vehicle lift.126

The company is building a network of fast charging stations, called the Tesla Supercharger, in North

America, Europe and Asia. Tesla provides this service to eliminate the inherent range problem of

123 Bankrate (05.04.2016), “Tesla buyers have long wait for Model 3” 124 Tesla Annual Report (2015), p. 8 125 IMCDB (02.05.2016), “Tesla Roadster in movies and TV series” 126 Tesla Annual Report (2015), p. 8


62

using an electric vehicle. Supercharging stations are strategically placed along well-travelled

highways to allow long-distance travel for Tesla users.127

3.3.3 VRIO

In this section, VRIO model is used to summarize the findings of value chain analysis and provide

groundings for the following SWOT analysis. The framework, developed by Barney J.B., is used to

analyse a firm’s internal resources and capabilities to determine whether they can be a source of

sustained competitive advantage. VRIO is an acronym that stands for four questions:

Does the resource or capability add value to the firm? Is it Valuable?

Is the control of the resource or capability in a hand of a few? Is it Rare?

Is it difficult or costly to Imitate?

Is the firm Organized to exploit the resource or capability?

According to the VRIO framework, resources or capabilities that meet all four requirements can

provide sustained competitive advantage for the company.

Resource/Capability Valuable Rare Difficult to imitate Exploited by the

organization

Competitive implications

Long delivery time No Competitive disadvantage

Vertical integration /

In-house production

Yes Yes Not in the long-run Temporary competitive

advantage

Company-owned stores Yes Yes Not in the long-run Temporary competitive

advantage

Company-owned service

centres

Yes Yes Not in the long-run Temporary competitive

advantage

State-of-the-art

technology

Yes Yes Not anymore in the

long-run

Temporary competitive

advantage

Gigafactory Yes Yes Yes No Unexploited competitive

advantage

Computer aided design

& crash test simulation

Yes Yes Yes Yes Sustained competitive

advantage

Expertise in lightweight

materials

Yes Yes Yes Yes Sustained competitive

advantage

Supercharging Yes Yes Yes Yes Sustained competitive a.

Elon Musk Yes Yes Yes Yes Sustained competitive a.



63

3.4 SWOT ANALYSIS

External analysis coupled with an industry analysis helps overseeing the macro and meso-level

environment of an organisation, thus determining its opportunities and threats. Internal analyses leads

to a better understanding of a firm’s micro environment, by analysing its key resources and

competences. It helps defining the company’s strengths and weaknesses and thereby its competitive

advantages relative to its peers. The main difference between external and internal aspects is that

internal factors can be influenced by the organisation, while external factors are out of its control.

The company can, therefore, use its strengths or opportunities in order to minimise its weaknesses

and threats. In overall, the SWOT model is used to summarize the Strengths, Weaknesses,

Opportunities and Threats likely to impact the firm’s ability to achieve its objectives. It provides an

overall picture of the company’s strategic positioning and helps deciding what changes to make.

Internal factors

Strengths

Outsourcing

Vertical integration

Production flexibility

Gigafactory

Employing top talent

Company structure that supports fast decision making &

innovation

State-of-the-art technology

Company-owned distribution network

Great after-sales services

Elon Musk

Weaknesses

Short operating history

Dependence on suppliers

Lack of lithium-ion batteries

Long delivery time

Low financial resources

External factors

Opportunities

Global economic growth

New market segment

Improved financial market conditions

Government regulations & incentives

Emission cheating scandal

Higher environmental awareness

Increasing crude oil price

Technological advancement

Albemarle Corporation

Manufacturing facility in China

Threats

Slowing Chinese economic growth

Forecasting errors

Ceasing government incentives

Increasing commodity prices

Higher supplier power

Dealership lawsuits

Bad media coverage

New entrants in the EV market


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3.4.1 STRENGTHS

There are several advantages that can position Tesla Motors in front of its competitors and contribute

to accomplish its goals. Outsourcing less relevant activities helps to minimize costs and enhance

efficiency by focusing resources on primary activities and value creation. Vertical integration, on the

other hand, allows Tesla to manufacture its most relevant components in-house, thereby ensuring

disruption-free production and high quality standards. Production flexibility enables Tesla to quickly

respond to changes in demand. Gigafactory will lead to reduction in battery costs through economies

of scale that will improve the competitiveness of future Tesla models.

Hiring top talent and allowing different departments to easily interact with each other generates an

innovative environment that leads to faster problem-solving and significant know-how creation. Flat

organization structure further facilitates communication that speeds up decision making and allows

quicker respond to external factors.

Expertise in fully electric vehicles, being in the forefront of autonomous driving, offering free over-

the-air software updates and installing a filtration system, which is so efficient that passengers can

even survive a military bio attack by sitting in the car, are such characteristics of the company that

differentiates it from other automakers. 128 Using state-of-the-art technologies enables Tesla to

develop and manufacture award-winning vehicles, thereby proving Tesla’s superiority over its

competitors.129

Company-owned distribution network ensure the same buying experience in every Tesla store that

further strengthen the brand. In addition, Tesla can make more profit per unit, while offering lower

prices for customers, by cutting out the middle man who would have charged extra money for its

services. Forward integration, therefore, allows higher margins and more competitive pricing.

Tesla knows that electric vehicles only gain popularity once the required infrastructure is available.

That is why, Tesla is building and expanding its own supercharging network that offers the world’s

fastest charging stations. 130 This unique after-sales service relieves range-anxiety and provides

competitive advantage for Tesla Motors. Company-owned service centres and mobile technicians

ensure that Tesla customers will have a fully functional vehicle after purchase, which further increases

trust in the brand. Tesla also found that opening a service centre can increase demand, which is why

128 Tesla Motors (02.05.2016), “Putting the Tesla HEPA Filter and Bioweapon Defense Mode to the Test” 129 Evannex (03.01.2016), “Tesla Model X wins top awards and honors” 130 Tesla Motors (04.05.2016), “Supercharger”


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the company complemented its store strategy with service centres. 131 Supercharging network,

coupled with company-owned service centres and mobile technicians accelerate the widespread

adoption of Tesla vehicles.

Elon Musk represents key competitive advantage that no competitor can duplicate. Besides having

the required skills, knowledge, vision and will power to make Tesla great, Musk has earned the

confidence of investors. He has already built billion dollar businesses, such as PayPal and SpaceX.

His current net worth is USD 13.5 billion, suggesting that he knows what he is doing.132

3.4.2 WEAKNESSES

Tesla has a short operating history in a highly complex industry. Consequently, it has limited

experience in designing, manufacturing and selling its products, which is why the company have

sometimes experienced unexpected delays that can also occur in the future. These delays mainly

caused by the company’s dependence on its suppliers, the majority of which are single-source

suppliers. If a supplier cannot deliver on a timely manner, Tesla will not be able to finish its vehicles

in time.

While Tesla Factory has a theoretical annual production capacity of 500,000 vehicles, it has utilized

only one fifth of it so far. Although the company has announced to reach its 500,000 total unit build

plan two years earlier than previously expected, the lack of adequate number of lithium-ion batteries

might hinder this plan.133 Tesla is already building its Gigafactory but it is expected to reach full

capacity only by 2020. Consequently, Tesla might have problems to satisfy increased demand for the

upcoming model. There is already an extremely high number of pre-orders for Model 3, but Musk

expects this number to climb up to half a million by the end of 2016.134 Considering the lack of

lithium-ion batteries, production capacity might not be able to rise fast enough to satisfy increased

demand. As a consequence, delivery time might rise up to years for those who place their orders

today. Potential customers who already reserved the new model might withdraw from the purchase,

if they have to wait for too long to receive their vehicles.135

131 Tesla Annual Report (2015), p.7 132 Forbes (04.05.2016), “Elon Musk” 133 Tesla Q1 2016 Shareholder Letter (04.05.2016), p. 1 134 The Verge (21.04.2016), “Tesla has received almost 400,000 preorders for the Model 3” 135 Fortune (01.04.2016), “Get Ready For a Long Wait Before Getting Your Tesla Model 3”


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Moreover, Tesla has less financial resources than well-established automobile manufacturers. It is

therefore more exposed to changes in the market that can adversely affect the company’s operating

results.136

3.4.3 OPPORTUNITIES

Moderate global economic growth is expected that most likely leads to moderate growth in global

vehicle sales, given the cyclical nature of the automotive industry, from which Tesla Motors can

benefit as well. While automotive is a mature industry, the electric vehicle segment is still at early

stages of the industry life cycle. It is currently in its introduction stage and the growth stage is yet to

come. Focusing solely on the EV segment, therefore, can provide great potentials for Tesla.

Improved financial market conditions provide easier access to credit that can boost economy and

vehicle sales in the future. Government regulations and incentives encourage both manufacturers and

customers to go green and choose environmental friendly vehicles, such as zero-emission Tesla

models. Some giant automotive companies have tried to cheat on emission tests that might leads to

tighter government control. In addition, some customer might lose faith in cheating companies

because the resale value of their vehicles have dropped immediately due to the scandal. Thus, Tesla

can gain customers by providing a more trustworthy brand. Studies prove that customers are more

environmentally conscious, and higher prices actually increases the desire for environmental-friendly

products. Tesla, therefore, may not have to worry about the price of its final products as long as the

hype for green products continuous.

Increasing crude oil price is good news for Tesla, because the higher the price of oil the more cost-

competitive electric vehicles become. It is particularly true for the U.S. market where people use

bigger cars for longer distances. Continuous technological advancement within the industry leads to

better performing and lower cost EVs that further increase their competitiveness.

In order to meet future demand, the company needs a stable supply of lithium. Albemarle Corporation

(ALB), located in Silver Peak, currently sells lithium to Panasonic, Tesla’s main battery supplier.

With the Gigafactory, however, Tesla aimed at producing its own batteries in the future that would

require a lithium supplier. It seems that the Gigafactory has been strategically positioned. It is only

four hour drive from Tesla Factory and three and half hour drive from Silver Peak. 137 Therefore, ALB

136 Tesla Annual Report (2015), p. 18 137 Nanalyze (19.08.2015), “The Likely Provider of Lithium for Tesla’s Gigafactory”


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would be a logical choice of lithium supplier for Tesla’s Gigafactory. By building a good relationship

with ALB, Tesla could secure stable supply of lithium for its future production.

Moreover, Tesla plays with the idea of setting up a manufacturing facility in China with a help of a

local partner. By doing so, the company would be able to avoid high import duties and entitled to

receive government incentives that mainly offered for locally produced vehicles. Consequently, Tesla

would have a better competitive position in the Asian market.

3.4.4 THREATS

While a moderate global economic growth is forecasted, GDP growth in China is expected to

gradually slow down. Slowing Chinese economic growth can negatively affect the entire automotive

industry as it has the world’s biggest auto market. There is also a chance that forecasts are bullish on

the prospects of future economic growth. Global vehicle sales growth was lower than world GDP

growth, which can be a sign of future economic slowdown.

Although governments provide incentives for electric vehicle owners, most of them will cease by the

end of the decade. Consequently, the price of EVs will go up, which mostly affect the more price-

sensitive customer base in the mass market, where Tesla is planning to enter with its new, lower-

priced model. Increasing commodity prices, such as aluminium, copper and nickel, can also cause

problems in the new market segment, where Tesla is less able to pass increase in raw material costs

to customers. With increasing demand, the price of lithium is also likely to rise in the future. The

majority of lithium is produced by only three companies that puts them in a strong bargaining

position. With the formation of mega suppliers that contribute over 80 per cent of value addition in

automobile production, bargaining power of suppliers is expected to further strengthen. This can lead

to higher production costs and lower profit margins.

Tesla is currently required to fight multiple legal battles for the right of selling its products directly

to customers in the United States. Losing in court would mean that Tesla has no access to its most

important market. Winning these court cases, therefore, is one of Tesla’s biggest challenges.

Moreover, any unexpected negative event, such as battery fires, can lead to exaggerated media

coverage that can harm Tesla’s reputation. Nonetheless, the truth behind these news are usually far


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from reality. Even though, there were only three Model S fires in which nobody got injured, Tesla

received more media attention than all 250,000+ gasoline fires combined in the respective year.138

Finally, Tesla is facing with increasing competitive pressure, as well-established automakers are

pushed to go green. These companies have the required resources and economies of scale to easily

enter the EV market.

CHAPTER 4 – FINANCIAL STATEMENT ANALYSIS

4.1 ANALYSIS OF ACCOUNTING POLICIES

International accounting standard 8 (IAS 8) defines accounting policies as “the specific principles,

bases, conventions, rules and practices applied by an entity in preparing and presenting financial

statements.“139 Reported financial data, therefore, is based on the firm’s chosen accounting policies

that may change over time. Changes in accounting policies can happen for two reasons:

Voluntary changes: management makes changes so financial statements can better describe

the firm’s performance and financial position.

Mandatory changes: new accounting standards have been introduced that should be adopted.

Changes in accounting policies might affect the company’s reported performance that influences

future growth potentials. Before carrying out a financial analysis, therefore, it is important to

determine changes in accounting policies and if necessary adjust reported financial data to eliminate

noise in the time-series analysis (see Appendix 11).

4.1.1 CHANGES IN REVENUE AND COST ALLOCATION

Revenues and costs from sales of pre-owned Tesla vehicles, sales of electric powertrain components

and systems to other manufacturers used to be recognised in ‘Automotive’. As of 2015, however,

these items are recognised in ‘Services and other’. 140 As a result, revenues and costs related to

‘Automotive’ have decreased, while revenues and costs related to ‘Services and other’ have increased.

It is important to note that the sum of ‘Automotive’ and ‘Service and other’ revenues and costs

remained the same. Changes in revenue and cost allocation, therefore, does not influence the

profitability of the company.

138 Tesla Motors (18.11.2013), “The Mission of Tesla” 139 European Commission (16.09.2009), “International Accounting Standard 8” 140 Tesla Annual Report (2014 & 2015), p. 49 & 38


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Although Tesla adjusted this change to previous years in its 2015 report, it only provides adjustments

until 2013. This means that data before 2013 is not adjusted to changes in revenue and cost allocation.

As Tesla does not provide separated revenue and cost information related to these items, it is not

possible to make adjustments by the author. This can create some noises in the time-series analysis.

4.1.2 CHANGES IN BALANCE SHEET ITEMS

Over the years, Tesla has made some changes in its balance sheet items. In some cases, it has only

changed the name of the balance sheet item. In other cases, it has integrated more balance sheet items

into one. The following balance sheet changes have been occurred over the investigated period:

‘Short term marketable securities’ and ‘Restricted cash’ ‘Restricted cash and marketable

securities’

‘Capital lease obligations’ and ‘Convertible senior notes’ ‘Long term debt and capital

leases’

‘Reservation payments’ ‘Customer deposits’

I have adjusted all of these balance sheet items over the investigated period to make them comparable.

Although the name and allocation of these items have changed, these changes had no effect on the

overall balance of assets and liabilities. ‘Prepaid expenses and other current assets’ and ‘Other long-

term liabilities’, however, both decreased that had an adverse effect on the balance sheet. Tesla does

not enclose any information related to these changes but states that it uses estimates and assumptions

in its financial statements preparations that can affect the reported amounts of assets and liabilities. It

also states that actual results could differ from these estimates.141 I assume that changes in these two

balance sheet items were caused by adjustments of estimates to actual results. Nevertheless, if latest

management estimates differ from actual numbers, the company’s performance can be either

overestimated or underestimated.

4.2 REFORMULATION OF THE INCOME STATEMENT AND BALANCE SHEET

Companies are made of operating, investing and financing activities. Operating activities are related

to the core business, hence these are what make the company unique and difficult to imitate, whereas

financing activities are only needed to provide sufficient funds to run the business. In other words,

operating activities are the primary driving forces behind value creation, thus it is important to



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separate them from financing activities when analysing the company.142 Tesla’s financial statements

do not make clear distinctions between operating items and financing items, therefore classification

of these items based on the author’s point of view.

4.2.1 ANALYTICAL INCOME STA TEMENT

Operating earnings show a company’s profit from its core business regardless of how it has been

financed. Investors, therefore, usually look at operating earnings as key performance measures. There

are three main options to measure operating earnings:

Earnings before interest, tax, depreciation and amortisation (EBITDA) = Total operating

revenues minus Total operating expenses

Earnings before interest and tax (EBIT) = EBITDA minus Depreciation and amortisation

Net operating profit after tax (NOPAT) = EBIT minus Tax on ordinary activities

By subtracting ‘Net interest expenses’ from NOPAT we get the company’s ‘Net earnings’. It is

important to note that interest-bearing expenses are tax-deductible. Since income statements do not

distinguish between tax on operations and tax on financial items, it is required to divide income tax

expenses into tax on operations and tax on financing to determine tax shield. Determining special

items is also relevant because they are not necessarily recurring, hence they cannot be forecasted.

Gains and losses on foreign currency transactions are recorded in ‘Other income (expenses), net’.143

As these gains and losses are impossible to be predicted, ‘Other income (expenses), net’ is classified

as a special item and separated from operating and financing items (see Appendix 12).

4.2.2 ANALYTICAL BALANCE SH EET

When reformatting financial statements, it is necessary to match items in the analytical balance sheet

with the related items in the analytical income statement. The purpose of separating operating items

from financing items in the analytical balance sheet is to determine ‘Net operating assets’ or ‘Invested

capital’ and how it is financed, i.e. the level of equity and net interest bearing debt (NIBD). Invested

capital, can either be calculated as the sum of operating assets minus operating liabilities, or the sum

of equity and NIBD. I have examined each balance sheet item to determine whether they belong to

operations or financing and had the following conclusion (see Appendix 12):

142 Petersen & Plenborg (2012), Financial Statement Analysis, p. 68 143 Tesla Annual Report (2015), pp. 55, 58


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Operating assets and liabilities Financing activities

‘Accounts receivable’

‘Inventory’

‘Accounts payable’

‘Accrued liabilities’

‘Deferred revenue’

‘Resale value guarantee’

‘Customer deposits’

‘Operating lease vehicles, net’

‘Property, plant and equipment, net’

‘Other assets’

‘Other long-term liabilities’

‘Cash and cash equivalents’

‘Restricted cash and marketable

securities’

‘Long-term debt and capital leases’

‘Common stock warrant liability’

Some items, such as ‘Restricted cash’ and ‘Resale value guarantee’, are both short-term and long-

term. In order to match items properly, both short-term and long-term parts were categorized as either

operating or financing activities. Tesla offers resale value guarantees to customers who finance their

purchase through one of Tesla’s commercial banking partners. Under this program, customers have

the option of selling their vehicle back to the company during the guarantee period for a pre-

determined resale value. Although Tesla receives full payment at the time of delivery, it is required

to account these transactions as operating leases.144 As these activities are part of Tesla’s main

business, ‘Operating lease vehicles’ and ‘Resale value guarantee’ are considered as operating items.

‘Cash and cash equivalents’ and ‘Restricted cash and marketable securities’ are comprised primarily

of money market funds, commercial papers and corporate debts that are not part of Tesla’s core

business, hence categorized as financing activities.145

4.3 FINANCIAL ANALYSIS

The aim of reformatting was to prepare financial statements for analytical purposes. In this section,

the company’s historical financial performance will be analysed, using the reformatted financial

statements. According to Petersen & Plenborg, this is required because “historical profitability is an

important element in defining the future expectations for a company”.146 The ultimate goal of the

144 Tesla Annual Report (2015), p. 53 145 Tesla Annual Report (2015), p. 55 146 Petersen & Plenborg (2012), Financial Statement Analysis, p. 93


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financial analysis is to determine trends in financial value drivers. In general, return on equity (ROE)

gives an overall picture of a company’s ability to create value for its shareholders, hence it is closely

watched by investors. The problem with simply relying on ROE when determining a company’s

attractiveness is that it fails to explain which factors drive value creation. Decomposition of ROE by

using the DuPont model, therefore, provides a much better understanding of the company’s financial

performance.147 As a result, the main focus of the financial analysis will be on the following areas

(see Appendix 13):

Operating efficiency

Asset use efficiency

Liquidity risk: short-term & long-term

4.3.1 OPERATING EFFICIENCY

There are many ways of calculating operating efficiency or profitability. In my analysis, I mainly

focus on ‘Gross margin’ and ‘Net profit margin’. ‘Gross margin’ shows ‘Gross profit’ as a percentage

of ‘Total revenues’. ‘Gross profit’ is the amount of money left after ‘Total cost of revenues’ have

been subtracted from ‘Total revenues’. Except for one year, Tesla has managed to have high ‘Gross

margin’ over the past five years thanks to selling vehicles in the premium market segment. In 2012,

this margin dropped partly because of higher automotive costs related to the introduction of Model

S. The company also experienced a slightly lower margin of 23 per cent in 2015 compared to the

previous year of 28 per cent. This was mainly caused by the start of Model X production and a higher

number of lower-priced vehicle sales. The company expects to increase the margin in 2016 due to

improving manufacturing efficiency.148

‘Net income’ is determined by deducting all expenses, including interest and tax costs from its ‘Total

revenue’. ‘Net profit margin’ is a ratio that measures how much income is kept in the company as

compared to the ‘Total revenue’. Simply put, it tells how much out of every dollar of sales a company

actually keeps in earnings. Tesla does not excel in this sense as it has only performed negative values

historically, due to high ‘Research and development’ (R&D) and ‘Selling, general and

administrative’ (SG&A) costs. High initial R&D expenses were caused by the development of

electric vehicles and powertrains, while SG&A costs were mainly related to the company-owned

distribution system. Although Tesla has managed to reduce negative ‘Net profit margin’ from minus

147 Petersen & Plenborg (2012), Financial Statement Analysis, p. 134 148 Tesla Annual Report (2015), p. 33


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125 per cent in 2011 to minus 9 per cent in 2014, the margin has dropped to minus 22 per cent in

2015 mainly due to lower ‘Gross margin’, which was explained above.

4.3.2 ASSET USE EFFICIENCY

The ‘Asset turnover ratio’ (ATR) is a measure of a company’s ability to use its assets to generate

revenue. It shows how well the managers used assets to generate sales. It is calculated through

dividing ‘Total revenue’ by ‘Total asset’. In general, the higher the ratio the more revenue generated

per dollar of assets, thus the more efficiently the company is in using its assets. Nonetheless, this ratio

varies between industries, hence it can only be compared between businesses in the same sector.

Tesla’s ATR varied between 0.47 and 1.29 over the investigated period. According to People’s United

Bank, automotive manufacturing companies tend to have lower than 1 ATR.149 ATR in the auto

manufacturing industry varied between 0.77 and 1.48 over the past five years.150 Consequently, Tesla

had average results in 2013 and 2014, but underperformed in 2011, 2012 and 2015. Below industry

standard results might require restructuring the company in order to improve efficiency.

The ‘Inventory turnover ratio’ (ITR) is a useful tool for evaluating how efficient management is at

managing company inventory. It calculates the number of times a company’s inventory is sold or

turned over a year. Higher ratio indicates that more sales have been generated, given a certain amount

of inventory. ‘Days sales of inventory’ (DSI) is an alternative way of evaluating inventory

management. It puts ITR into daily context by taking the inverse of ITR and multiplying it by 365.

In other words, it shows how rapidly the company sells its inventory. Tesla had a DSI of 237.15 in

2012, meaning it took the company more than 237 days to deliver its products to customers. As a

consequence, the company generated less revenue that led to a lower ‘Gross margin’ in the respective

year. Tesla has managed to lower DSI, but it is still relatively high and requires further improvements.

In its first quarter 2016 shareholder letter, Tesla confirmed that it is working on improved working

capital management and inventory control.151

4.3.3 L IQUIDITY RISK

As it was mentioned in section 4.2, financing activities are required to supply adequate capital for

operations. It generally means that without liquidity a firm will not be able to pay its invoices or

implement profitable investments. Moreover, in extreme situations the lack of liquidity can lead to

149 People’s United Bank (21.05.2016), “Total Assets Turnover” 150 CSI Market (21.05.2016), “Auto & Truck Manufacturers Industry” 151 Tesla Q1 2016 Shareholder Letter (04.05.2016), p. 2


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bankruptcy. Therefore, it is crucial to analyse a company’s short-term and long-term liquidity risk

when determining its financial performance and future profitability.

4.3.3 .1 SH ORT -TERM L I QUID ITY R ISK

Short-term liquidity risk reveals the company’s ability to satisfy its short-term obligations, i.e. usually

payments due within 12 months. ‘Current ratio’ or ‘Working capital ratio’ considers ‘Current assets’

relative to ‘Current liabilities’. This ratio, however, can be misleading if a firm’s current assets are

heavily weighted in favour of inventories, because inventories can be difficult to liquidate in short-

term. Low ‘Inventory turnover ratio’ is an indication of less accurate ‘Current ratio’.

It is a good idea to find the ‘Quick ratio’, which is a more conservative indicator of the short-term

liquidity risk, as it includes only the most liquid current assets by excluding the impact of inventory.

It is equal to (‘Current assets’ minus ‘Inventory’) divided by ‘Current liabilities’. Nonetheless, both

‘Current ratio’ and ‘Quick ratio’ attempt to answer the same questions:

What is the likelihood that current assets cover current liabilities in the event of liquidation?

In general, the larger the ratio, the greater the likelihood that the sale of current assets is able to cover

short-term obligations. However, ratios can only be compared between companies within the same

industry. Tesla’s ‘Current ratio’ ranged between 0.97 and 1.95, while its ‘Quick ratio’ varied between

0.48 and 1.69 over the past five years. Since Tesla is both manufacturing and selling its vehicles, it is

not 100 per cent comparable with other auto manufacturers, or retailers. Auto retailers’ had a ‘Current

ratio’ between 1.17 and 1.72, and a ‘Quick ratio’ between 0.14 and 0.26 over the investigated

period.152 Auto manufacturers had somewhat higher numbers of 1.54 and 2.43, and 0.41 and 0.63 for

these ratios in respective years.153 It means that Tesla has over performed auto retailers in 2011 and

2013, in terms of ‘Current ratio’, but only had average results compared to auto manufacturers. Last

year, nevertheless, the ratio dropped to 0.99, which is an indication of slightly higher short-term

liquidity risk. When comparing Tesla’s ‘Quick ratio’ to auto retailers or auto manufacturers, however,

we find that the company had better results than the industry. It is important to note that Tesla had

significantly lower ‘Quick ratio’ compared to its ‘Current ratio’ in 2012 and 2015, which was a result

of higher portion of inventory in current assets. Lower ‘Inventory turnover ratio’ in respective years

also supports this conclusion.

152 CSI Market (21.05.2016), “Retail sector” 153 CSI Market (21.05.2016), “Auto & Truck Manufacturers Industry”


75

Although these ratios are useful to calculate, comparing them with industry averages can be

misleading. The reason is that automotive is a mature industry, while Tesla is still in its early stage

of its lifecycle, which is characterised by high investments and low or no earnings. The ‘Cash burn

rate’ (CBR) is typically used on companies with negative earnings, hence an effective measure of

Tesla’s short-term liquidity risk. It estimates how long a company is able to continue its operations

assuming its current performance and no further cash contribution from shareholders or creditors.

Tesla had extremely high CBRs of 177.10 and 138.95 in 2013 and 2014 that were coupled with high

‘Current ratio’ and ‘Quick ratio’. Although the company had a lower CBR of 23.78 in 2015, it was

8.44 higher than the CBR of 15.34 in 2011. To understand the significance of this difference, we

should compare the rest of the ratios in the respective years. Both ‘Current ratio’ and ‘Quick ratio’

were higher in 2011 than in 2015, indicating a lower short-term liquidity risk in 2011 than in 2015.

Nonetheless, the CBR showed that Tesla could have continued its operations for more than 8 months

longer in 2015 than in 2011 without any further cash contribution. Consequently, the CBR proved to

be a better measure for short-term liquidity risk in these years.

4.3.3 .2 LONG-TER M LIQ UID ITY R ISK

There are a variety of ratios that measure long-term liquidity risk that refers to a company’s ability to

satisfy its long-term obligations. The ‘Debt-to-Equity ratio’, also known as ‘Financial leverage,’

shows the proportion of NIBD to equity. Tesla had negative values in 2011 and 2013 because of

negative NIBD. It means that the company had more cash and cash equivalents than financial debt,

hence it was “cash positive”. It is usually a good sign but it can also reflect poor capital allocation, as

the excess cash was not used for value creation. Tesla has increased its ‘Financial leverage’ to 1.26

in 2015, which was still below the industry average of 2.57.154 While higher ‘Financial leverage’

means higher long-term liquidity risk, increasing the leverage to a certain level is favourable because

debt-financing is cheaper than equity-financing, as interest on debt it tax-deductible. Thus, the

adequate level of ‘Financial leverage’ can support growth.

The ‘Solvency ratio’ measures the rate of equity to invested capital, i.e. equity plus NIBD. A lower

ratio means that a lower part of invested capital is financed through equity and a higher part is

financed by debt. Thus, the lower a company’s ‘Solvency ratio’, the higher the chance that it will

default on its debt obligations. The recommended value of this ratio for automobile factories is above

154 CSI Market (21.05.2016), “Auto & Truck Manufacturers Industry”


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0.5.155 Tesla historically had high ‘Solvency ratio’, which has decreased due to increase in ‘Financial

leverage’. Although it increases long-term liquidity risk, it was argued that a certain level of

‘Financial leverage’ can boost growth. The ‘Equity multiplier’ computes the ratio of total assets to

stockholders’ equity. Companies finance the purchase of assets either through debt or equity.

Consequently, a higher ‘Equity multiplier’ indicates that a larger portion assets was financed by debt,

which means higher long-term liquidity risk. The multiplier, therefore, is a variation of ‘Financial

leverage’. Calculating the ‘Equity multiplier’ enables us to decompose ROE through the following

equation: ROE = Net profit margin * Asset turnover rate * Equity multiplier.

In overall, Tesla used to have low short-term liquidity risk and moderate long-term liquidity risk.

Nevertheless, last year’s results show that short-term liquidity risk has increased to moderate level

but the company would be able to continue its operations without any further cash contribution for

almost two years assuming its current performance. Long-term liquidity risk has also risen but it is

not necessarily a bad sign, as higher ‘Financial leverage’ can boost company growth through cheaper

financing. However, Tesla should find the adequate level of financial leverage, as too high leverage

can lead to failure in future payments.

Last but not least, it is important to note that all of these financial ratios are based on historical

accounting data and therefore are backward looking. As a consequence, while examining historical

financial data is important, it might be a good idea to put more weight on strategic value drivers when

determining future company performance.

CHAPTER 5 – FORECASTING

The previous chapter has focused on accounting data and the measurement of Tesla’s historical

profitability, growth and risk. In this chapter the focus of analysis changes from a historical view to

a forward-looking view by developing the company’s pro forma financial statements, which will be

used for valuation purposes. The pro forma income statements follow the same approach as the

reformulated income statements, which separate operating activities from financing activities. As

noted in section 4.2, operating activities are the primary driving forces behind value creation, hence

they are important to measure when forecasting future earnings.

155 Credinform (09.02.2015), “Solvency ratio of automobile factories”


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As it was mentioned earlier, Tesla mainly earns money through selling electric vehicles, electric

vehicle powertrain components and stationary energy storage systems. Most of its expenses are,

therefore, primarily related to the development, manufacturing and sales of these items. That is why,

I have chosen to use a sales-driven forecasting approach. Forecasting assumptions are based on the

analysis of historical financial performance, and the assessment of current and future outlook of

strategic value drivers. This paper, therefore, separates the ‘Historical period’ from the ‘Explicit

forecasting period’ and the ‘Terminal period’. The ‘Historical period’ provides insights about the

trends of financial value drivers, thus used as a foundation for forecasting. In the ‘Explicit forecasting

period’ financial value drivers are expected to change to either one direction or to another, depending

on the findings of the strategic analysis. The ‘Terminal period’, on the other hand, refers to a ‘steady

state’ environment and shows the company’s long-term growth potentials. The summary of

forecasting assumptions can be found in Appendix 14. When values are constant, I simply took the

average of historical rates. Findings of the strategic analysis, however, required to predict some ratios

on a yearly basis. The following forecasting assumptions were made when preparing the pro forma

statements:

Automotive revenue growth: it is based on the assumption that Tesla will achieve its plan of

producing 500,000 vehicles by 2018. Considering last year’s production level, this would

require to increase yearly production capacity by a CAGR of ~ 114 per cent. However, I

expect this increase to gradually slow down after 2018. The product mix is expected to shift

in favour of Model 3 that will negatively affect Model S and Model X sales in the long-run.

Based on historical data, I expect 80 per cent delivery rate. I calculated Model S and Model

X prices by using the average prices found on the company’s website. I used Elon Musk’s

estimate of USD 42,000 for Model 3 pricing. Moreover, I used the average expected inflation

rate of Tesla’s main markets to get the discounted value of future vehicle prices (see Appendix

15).

Gross margin: as it was mentioned earlier, Tesla expects to rise the margin in 2016 due to

improving manufacturing efficiency. With the shift in product mix to lower-priced vehicles,

however, I expect this margin to gradually go down to 20 per cent in the following years.

From 2020, nonetheless, I do not expect it to further decrease because of battery cost

reductions, improving economies of scale and the fact that Tesla sells electric vehicles that

carry social value.


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Effective tax rate: it was determined by the estimated industry average.156

Effective interest rate: Tesla amortises its convertible notes at an effective interest rates of

4.89 per cent and 5.96 per cent.157 I have calculated the average effective interest rate by

dividing total interest by the total principal amount of convertible notes (see Appendix 16).

R&D and SG&A: it was noted that Tesla is still in its introduction stage of its lifecycle, which

requires high initial investments. As the company moves to its growth stage with higher

number of sales, these expenses will make up a smaller part of its total revenue.

Inventory and Total current liabilities: section 4.3.2 mentioned that Tesla is working on

improved working capital management and better inventory control, which means decreasing

values in these ratios.

Operating lease vehicles, Resale value guarantee and Deferred revenue: there is an extremely

high number of Model 3 reservations already that will not be financed through leasing

partners, thus income from leasing to total income is expected to drop in the future.

PP&E: it is assumed to remain relatively high, as increasing production capacity requires

substantial amount of investments. Nonetheless, due to higher number of vehicle sales, fix

cost per sale will drop gradually.

Based on these forecasting assumption, I have found that Tesla will have a positive EBITDA from

2016 but reaches positive EBIT, NOPAT and Net income only from 2017 (see Appendix 17).

CHAPTER 6 – VALUATION

Once future profitability and financing is predicted, company value can be estimated. As it was

explained in the methodology section, I chose the DCF and the EVA present value models to compute

the enterprise value of Tesla Motors. These valuation models, however, require further assumptions

on the terminal growth rate and the company’s required rate of return, i.e. WACC. In section 3.1.2,

the world economic growth prospect of 2020 was ~ 3.76 per cent. It was also noted that automotive

is a cyclical industry, thus industry performance largely related to the economic cycle. As I assume

that Tesla will grow with the world average in the long-run, I used the terminal growth rate of 3.76

per cent. The weighted average cost of capital is calculated as: 158

156 New York University Stern School of Business (01.01.2016), “Debt fundamentals by sector” 157 Tesla Annual Report (2015), p. 64 158 Petersen & Plenborg (2012), Financial Statement Analysis, p. 96


79

𝑊𝐴𝐶𝐶 =𝑁𝐼𝐵𝐷

𝑁𝐼𝐵𝐷 + 𝑀𝑉𝐸∗ 𝑅𝑑 ∗ (1 − 𝑡) +

𝑀𝑉𝐸

𝑁𝐼𝐵𝐷 + 𝑀𝑉𝐸∗ 𝑅𝑒

The required rate of return to equity holders (Re) is determined by the risk-free rate, the company’s

beta and the market risk premium. The risk-free rate is based on the five year average of U.S. 10-year

bond yield from 1st May 2011 to 1st May 2016.159 Tesla’s beta was collected from Reuters, which is

considered to be a reliable source.160 I used professor Damodaran’s estimated equity risk premium.161

Based on these inputs, Tesla’s calculated WACC is ~ 8.63 per cent (see Appendix 18).

6.1 THE DISCOUNTED CASH FLOW APPROACH

The DCF model calculates the present value of future free cash flows to firm in order to measure firm

value. Therefore, the enterprise value is calculated by using the following equation:162

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒 = ∑𝐹𝐶𝐹𝐹𝑡

(1 + 𝑊𝐴𝐶𝐶)𝑡

∞

𝑡=1

According to this equation, only the free cash flows to the firm and WACC affect the market value

of a company. This means that the value of Tesla Motors increases when it has higher FCFF and

lower WACC.

Numbers in USD 1000 2014 2015 2016 2017 2018 2019 2020

DCF Model

NOPAT -732036 -268028 319997,4 1097809 2091514 3407605

Net operating assets (Invested capital)

1464756 2501860 4159929 6624877 9630220 11561211 10443820

Δ Net operating assets 1037104 1658069 2464949 3005343 1930991 -1117391

Discount years 0 1 2 3 4 5 Terminal period

Free cash flow to the firm

-1769139 -1926097 -2144951 -1907534 160522,8 4524995

PV of FCFF -1769139 -1773047 -1817613 -1487984 115267 2991080 3103545

PV of FCFF in forecast horizon

-1972296

PV of FCFF in terminal period

42107095

Estimated enterprise value

40134799

Net interest-bearing debt

1422483

Estimated market value of equity

38712316

159 Investing.com (01.05.2011 – 01.05.2016), “U.S. 10-Year Bond Yield” 160 Reuters (18.05.2016), “Tesla Motors Inc” 161 Damodaran (11.02.2016), “Implied equity risk premium” 162 Petersen & Plenborg (2012), Financial Statement Analysis, p. 216


80

Calculations show that Tesla will only have positive FCFF from 2019, leading to a negative overall

FCFF in the forecast horizon. It is mainly due to the high initial investments required to be able to

enhance production capacity to 500,000 units per year by 2018. Estimated enterprise value of ~ USD

40.13 billion, therefore, stems from the present value of FCFF in the terminal period. To get the

estimated market value of equity, net interest-bearing debt is subtracted from the estimated enterprise

value. This resulted an estimated market value of equity of ~ USD 38.71 billion.

6.2 THE ECONOMIC VALUE ADDED APPROACH

The EVA model ads the invested capital from the last fiscal year to the present value of all future

EVAs to estimate the value of a company. The enterprise value, therefore, is calculated by the

following equation:163

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒 = 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 + ∑𝐸𝑉𝐴𝑡

(1 + 𝑊𝐴𝐶𝐶)𝑡

∞

𝑡=1

According to the above equation, the value of Tesla Motors is positively affected by higher future

EVAs and a lower WACC.

Numbers in USD 1000

EVA model

Discount years 0 1 2 3 4 5 Terminal period

NOPAT -732036 -268028 319997 1097809 2091514 3407605


2501860 4159929 6624877 9630220 11561211 10443820

EVA -483990 -39090 525946 1260227 2409634 2500236

Present value of EVA -445532 -39090 525946 1260227 2409634

PV of EVA in forecast horizon 3711185

PV of EVA in terminal period 33921754


2501860

Estimated enterprise value 40134799

Net interest-bearing debt 1422483

Estimated market value of equity

38712316

No. of shares (in thousands) 145 880

Share price 265.37

Because the EVA model uses NOPAT, which is assumed to be positive from 2017, instead of FCFF,

the company will have a positive present value in the forecast horizon. Nevertheless, enterprise value



81

is still mainly based on the present value of EVA in the terminal period. Although the DCF model

and the EVA model use different methods, these are theoretically equivalent approaches.

Consequently, the EVA model leads to the same estimated enterprise value of ~ USD 40.13 billion,

and estimated market value of equity of ~ USD 38.71 billion as the DCF model.

As of 23th May 2016, Tesla Motors had 145.88 million shares outstanding.164 Dividing the estimated

market value of equity by the number of outstanding shares resulted a share price of ~ USD 265.37.

One Tesla share was traded at USD 216.22 at Nasdaq Stock Exchange on the same day. Consequently,

I believe that the company is currently undervalued and its share price is going to rise in the future.

CHAPTER 7 – SENSITIVITY ANALYSIS

According to Petersen & Plenborg, “a valuation should always be accompanied by a sensitivity

analysis that examines the valuation consequences of changing some of the key value drivers”.165 The

previous chapter has revealed that the terminal value accounts for the majority of Tesla’s enterprise

value. Moreover, the pro forma statements showed that future profitability is largely based on what

gross margin the company is capable to capture. Therefore, I conducted a sensitivity analysis of the

terminal growth rate and the gross margin.

Terminal growth rate

2.76% 3.26% 3.76% 4.26% 4.76%

Gro

ss m

argi

n

19.0% 192.16 213.53 239.28 270.92 310.74

19.5% 203.03 225.38 252.32 285.43 327.08

20.0% 213.91 237.24 265.37 299.93 343.42

20.5% 224.78 249.10 278.42 314.44 359.76

21.0% 235.66 260.96 291.46 328.94 376.10

The above table depicts that Tesla’s share price is sensitive to both factors. A change of 0.5 per cent

in gross margin would change the share price with ~ USD 13 in either direction, while the same

change in terminal growth rate would push the share price either up or down with ~ USD 30.

164 Reuters (24.05.2016), “Tesla Motors Inc” 165 Petersen & Plenborg (2012), Financial Statement Analysis, p. 241


82

It was also noted in the previous chapter that the WACC influences the outcome of the valuation.

Therefore, I found it relevant to make a sensitivity analysis of the risk-free interest rate and beta.

Risk-free rate

1.17% 1.67% 2.17% 2.67% 3.17% B

eta

1.29 376.81 336.41 301.96 272.13 246.22

1.34 350.79 314.23 282.86 255.53 231.69

1.39 327.28 294.05 265.37 240.27 218.26

1.44 305.93 275.62 249.32 226.19 205.83

1.49 286.48 258.74 234.55 213.18 194.30

The above table shows that the price of a Tesla share is highly sensitive to these factors as well. A

change of 0.5 per cent in the risk-free rate moves the share price with ~ USD 25, while a change of

0.05 in beta affect the price by ~ USD 17.

CHAPTER 8 – CONCLUSION

The aim of this paper was to estimate the fair value of one Tesla Motors share as of 23.05.2016, thus

challenge the current market price of USD 216.22. This topic was chosen due to the company’s high

historical stock price volatility and analysts’ distinct opinions of Tesla’s correct share price. As the

company is still in its early stage of its life cycle, which is characterised by high investments and

negative operating profit, determining the right stock price was even more challenging.

Over the past five years, Tesla grew total revenues by almost 19 times and the stock price followed

on with a rage of ~ USD 22 and USD 286, reaching its peak in July 2015. Ever since, Tesla’s share

price has dropped to the current market price. It was mainly due to lower than expected deliveries

and some analysts’ lower price targets, caused by the company’s announcement of advancing its

500,000 unit build plan by two years to 2018, which would require higher spending in the upcoming

years than earlier planned.

The strategic analysis has revealed that the company is operating in an attractive industry, i.e. electric

vehicle segment, but competitive rivalry is expected to rise as well-established manufacturers enter

the EV segment. Tesla possesses temporary competitive advantage through vertical integration,

company-owned distribution system and application of stat-of-the-art technologies. It has sustained

competitive advantage thanks to, inter alia, expertise in lightweight materials, supercharging network


83

and employing Elon Musk as CEO. Once the Gigafactory is built, it will provide sustained

competitive advantage as well.

Tesla is dependent on several single source suppliers that led to delays in delivery. With an extremely

high demand for Model 3, delivery time can rise to years that might result cancellations of purchase.

Although Tesla plans to enhance production capacity by 2018, the Gigafactory is expected reach full

capacity only by 2020. The company, therefore, might face with a lack of lithium-ion batteries in the

future. Moreover, these investments require a substantial amount of capital. However, Tesla has far

less financial resources than its biggest competitors.

Tesla’s future profitability is dependent on raw material prices that are expected to rise in the

upcoming years. In addition, a shift in product mix in favour of the lower-priced Model 3 would

further decrease gross margin. However, technology advancements will results lower battery costs

and improved manufacturing efficiency that would offset these negative effects on the long-run.

The company had low short-term and moderate long-term liquidity risk historically. However, both

short-term and long-term liquidity risk has risen over the last year. Financial leverage is expected to

further increase as enhancement of production capacity requires further investments. Nonetheless, it

was argued that the adequate level of financial leverage can boost value creation through cheaper

financing.

Based on my forecasting assumptions, Tesla will have a positive EBITDA from 2016 but reaches

positive EBIT, NOPAT and net income only from 2017. Using the DCF model and the EVA model,

this would result a positive FCFF from 2019 and a positive EVA from 2018. While these models use

different methods, they theoretically equivalent approaches, thus resulted the same estimated

enterprise value of ~ USD 40.13 billion and estimated market value of equity of ~ USD 38.71 billion.

After dividing the estimated market value of equity by the number of outstanding shares, I received

an estimated fair value of ~ USD 265.37 of one Tesla Motors share as of 23.05.2016. This is higher

than the current market price but close to the consensus price target of USD 278.41. Therefore, I

conclude that the company is currently undervalued and its share price is going to rise in the future.

The sensitivity analysis, however, has revealed that the estimated share price is sensitive to changes

in key value drivers and underlines the importance of devoting the time necessary to prepare realistic

pro forma statements.


84

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http://www.theverge.com/2016/4/21/11477034/tesla-model-3-preorders-400000-elon-musk


91

Tesla Motors (28.04.2016), “Careers”

https://www.teslamotors.com/careers/job/engineer-massproperties-31757

Radius (28.04.2016), “Tesla Motors: Achieving Excellence and Innovation Overseas”

http://www.radiusworldwide.com/knowledge/case-studies/case-study-tesla-motors

Fortune (05.02.2016), “Here's What's Behind Tesla's Long, Slow Stock Slide”

http://fortune.com/2016/02/05/heres-whats-behind-teslas-long-slow-stock-slide/

Bankrate (05.04.2016), “Tesla buyers have long wait for Model 3”

http://www.bankrate.com/financing/cars/tesla-buyers-have-long-wait-for-model-3/

The Week (05.05.2016), “Oil prices boosted by Canadian wildfire and Libyan unrest”

http://www.theweek.co.uk/oil-price/60838/oil-prices-boosted-by-canadian-wildfire-and-libyan-unrest

The Wall Street Journal (05.05.2016), “How Tesla Is Shaking Up Metals Markets”

http://blogs.wsj.com/moneybeat/2016/05/05/how-tesla-is-shaking-up-metals-markets/

Internatonal Business Times (05.05.2016), “Tesla Motors Inc. (TSLA) Shares Fall”

http://www.ibtimes.com/tesla-motors-inc-tsla-shares-fall-company-says-it-will-spend-more-2016-

previously-2364867

Reuters (18.05.2016), “Tesla Motors Inc”

http://in.reuters.com/finance/stocks/overview?symbol=TSLA.O

People’s United Bank (21.05.2016), “Total Assets Turnover”

https://businessresources.peoples.com/SBR_template.cfm?DocNumber=PL10_0080.htm

CSI Market (21.05.2016), “Auto & Truck Manufacturers Industry”

http://csimarket.com/Industry/industry_Efficiency.php?ind=404

Tesla Motors (23.05.2016), “Board of Directors Elon Musk”.

http://ir.teslamotors.com/directors.cfm

Global Rates (07.01.2016), “ECB refi rate - European Central Bank’s interest rate”

http://www.global-rates.com/interest-rates/central-banks/european-central-bank/ecb-interest-rate.aspx

The Verge (07.04.2016), “Tesla has received 325,000 preorders for the Model 3”

http://www.theverge.com/2016/4/7/11385146/tesla-model-3-preorders-375000-elon-musk

Tesla Motors (08.04.2016), “Tesla Energy”

https://www.teslamotors.com/presskit/teslaenergy


92

Damodaran (11.02.2016), “Implied equity risk premium”

http://pages.stern.nyu.edu/~adamodar/

The Motley Fool (11.04.2016), “The Most Compelling Argument for How Tesla Motors Is a Tech

Company”

http://www.fool.com/investing/general/2016/04/11/the-most-compelling-argument-for-how-tesla-

motors.aspx


93

APPENDIX

Appendix 1: Excess emission premium calculation

The excess emissions premium shall be calculated using the following formulae:

From 2012 until 2018:

o Where the manufacturer's average specific emissions of CO2 exceed its specific

emissions target by more than 3 g CO2/km: ((Excess emissions – 3 g CO2/km) × 95

€/g CO2/km + 1 g CO2/km × 25 €/g CO2/km + 1 g CO2/km × 15 €/g CO2/km + 1 g

CO2/km × 5 €/g CO2/km) × number of new passenger cars.


emissions target by more than 2 g CO2/km but no more than 3 g CO2/km: ((Excess

emissions – 2 g CO2/km) × 25 €/g CO2/km + 1 g CO2/km × 15 €/g CO2/km + 1 g

CO2/km × 5 €/g CO2/km) × number of new passenger cars.


emissions target by more than 1 but no more than 2 g CO2/km: ((Excess emissions –

1 g CO2/km) × 15 €/g CO2/km + 1 g CO2/km × 5 €/g CO2/km) × number of new

passenger cars.


emissions target by no more than 1 g CO2/km: (Excess emissions × 5 €/g CO2/km) ×

number of new passenger cars.

From 2019:

o (Excess emissions × 95 €/g CO2/km) × number of new passenger cars.


94

Appendix 2: Overview of purchase and tax incentives for electric vehicles in the EU in 2015

Austria:

Electric vehicles are exempt from the fuel consumption tax and from the monthly vehicle tax.

Belgium:

Electric and plug‐in hybrid vehicles are exempt from registration tax in Flanders.

Electric vehicles pay the lowest rate of tax under the annual circulation tax in all three regions.

The deductibility from corporate income of expenses related to the use of company cars is

120% for zero‐emissions vehicles and 100% for vehicles emitting between 1 and 60 g/km of

CO 2. Above 60 g/km, the deductibility rate decreases gradually from 90% to 50%.

Bulgaria:

None

Croatia:

None

Cyprus:

None

Czech Republic:

Electric, hybrid and other alternative fuel vehicles are exempt from the road tax (this tax

applies to cars used for business purposes only).

Denmark:

Electric vehicles weighing less than 2,000 kg are exempt from the registration tax. This

exemption does not apply to hybrid vehicles.

Estonia:

None


95

Finland:

Electric vehicles pay the minimum rate (5%) of the CO2 based registration tax.

France:

Electric and hybrid electric vehicles emitting 20 g/km or less of CO 2 benefit from a premium

of € 6,300 under a bonus‐malus scheme. For vehicles emitting between 20 and 60 g/km, the

premium is € 4,000. For vehicles emitting between 61 and 110 g/km, it is maximum € 2,000.

The amount of the incentive cannot exceed a given percentage of the vehicle purchase price

including VAT, increased with the cost of the battery if this is rented. For vehicles emitting

less than 20 g/km, this is 27% of the purchase price, for vehicles emitting between 20 and 61

g/km, it is 20% and for vehicles emitting between 61 and 110 g/km, it is 5%.

Electric vehicles are exempt from the company car tax. Hybrid vehicles emitting less than 110

g/km are exempt during the first two years after registration.

Germany:

Electric vehicles are exempt from the annual circulation tax for a period of ten years from the

date of their first registration.

Greece:

Electric and hybrid vehicles are exempt from the registration tax, the luxury tax and the luxury

living tax.

Electric and hybrid passenger cars with an engine capacity up to 1,929 cc are exempt from

the annual circulation tax. Hybrid cars with a higher engine capacity pay 50% of the normal

circulation tax rate.

Hungary:

Electric vehicles are exempt from the registration tax and the annual circulation tax.

Ireland:

Electric vehicles benefit from VRT (registration tax) relief up to a maximum of € 5,000. For

plug‐in hybrids, the maximum relief is € 2,500. For conventional hybrid vehicles and other

flexible fuel vehicles, the maximum relief is € 1,500. In addition, electric and plug‐in hybrid

vehicles receive a grant of up to € 5,000 on purchase.


96

Italy:

Electric vehicles are exempt from the annual circulation tax (ownership tax) for a period of

five years from the date of their first registration. After this five‐year period, they benefit from

a 75% reduction of the tax rate applied to equivalent petrol vehicles in many regions.

Latvia:

Electric vehicles are exempt from the registration tax.

Lithuania:

None

Luxembourg:

None

Malta:

None

Netherlands:

Electric vehicles are exempt from the registration tax BPM.

Vehicles emitting maximum 50 g/km of CO 2 are exempt from the annual circulation tax.

Poland:

None

Portugal:

Electric vehicles are exempt from the registration tax ISV and from the annual circulation tax.

Hybrid vehicles benefit from a 40% reduction of the registration tax.

Romania:

Electric and hybrid vehicles are exempt from the registration tax


97

Slovakia:

Electric vehicles are exempt from the annual circulation tax. Hybrid vehicles benefit from a

50% reduction of the annual circulation tax (this tax applies only to vehicles used for business

purposes).

Slovenia:

None

Spain:

None

Sweden:

Five year exemption from paying annual circulation tax: Electric vehicles with an energy

consumption of 37 kWh per 100 km or less are exempt from the annual circulation tax for a

period of five years from the first registration. The same five year exemption applies to electric

hybrid and plug‐in hybrid vehicles that fulfil the new green car definition applied for new

registrations from 1 January 2013. The definition is dependent on the CO2 emission in relation

to the curb weight of the car. The formula for petrol, diesel, electric hybrid cars and plug‐in

cars is as follows: Maximum CO2‐emission allowed=95 g/km CO2‐emission + 0.0457 x (the

curb weight of the car – 1372 kg curb weight). Moreover, for both electric cars and plug‐in

hybrids the electrical energy consumption per 100 km must not exceed 37 kWh to be regarded

as a green car.

Reduction of company car taxation: For electric and plug‐in hybrid vehicles, the taxable value

of the car for the purposes of calculating the benefit in kind of a company car under personal

income tax is reduced by 40% compared with the corresponding or comparable petrol or diesel

car. The maximum reduction of the taxable value is SEK 16,000 per year.

Super green car premium new cars: A so called “Super green car premium”

(Supermiljöbilspremie) of SEK 40,000 is available for the purchase of new cars with CO2

emissions of maximum 50 g/km. The premium is applied both for the purchase by private

persons and companies. For companies purchasing a super green car, the premium is

calculated as 35% of the price difference between the super green car and a corresponding


98

petrol/diesel car, with a maximum of SEK 40,000. The premium was introduced in 2012 and

will be paid also in 2015 as long as the funds are sufficient to pay the premium.

United Kingdom:

Purchasers of electric vehicles and plug‐in hybrid vehicles with CO2 emissions below 75 g/km

receive a grant of up to £ 5,000. There are three categories:

o Category 1: CO2 emissions of less than 50 g/km and a zero emission range of at least

70 miles

o Category 2: CO2 emissions of less than 50 g/km and a zero emission range between

10 and 69 miles

o Category 3: CO2 emissions of 50‐75 g/km and a zero emission range of at least 20

miles

Electric vehicles are exempt from the annual circulation tax. This tax is based on CO2

emissions and all vehicles with emissions below 100 g/km are exempt from it.


99

Appendix 3: Correlation between GDP growth and vehicle sales growth

World 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP growth 4.1% 3.9% 1.5% -2.1% 4.1% 2.8% 2.2% 2.4% 2.5% 2.8%

Vehicle sales

growth

3.7% 4.7% -4.5% -4.0% 14.3% 4.3% 5.1% 4.2% 3.0% 2.0%

Correlation

coefficient

0.72

European Union 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP growth 3.4% 3.1% 0.5% -4.4% 2.1% 1.8% -0.5% 0.1% 1.3% 1.9%

Vehicle sales

growth

3.8% 5.2% -4.9% -14.8% 0.9% 5.0% -5.5% -1.7% 0.8% 9.8%

Correlation

coefficient

0.56

USA 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP growth 2.7% 1.8% -0.3% -2.8% 2.5% 1.6% 2.3% 2.2% 2.4% 2.7%

Vehicle sales

growth

0.1% 1.1% -11.4% -16.3% 12.7% 9.4% 9.7% 5.7% 1.8% 5.7%

Correlation

coefficient

0.84

China 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP growth 12.7% 14.2% 9.6% 9.2% 10.6% 9.5% 7.8% 7.7% 7.4% 7.1%

Vehicle sales

growth

25.3% 21.8% 6.7% 45.5% 32.4% 2.5% 4.3% 13.9% 6.9% 4.7%

Correlation

coefficient

0.45

Source: Compiled by author / World Bank / OICA


100

Appendix 4: CAPEX of World’s ten largest automobile OMEs

In USD million, 2014 Net sales Capital expenditures CAPEX to sales ratio

Volkswagen 200858 13005 6.47%

Toyota 222825 8890 3.99%

Hyundai 77832 2925 3.76%

General Motors 155929 7039 4.51%

Honda 108536 7167 6.60%

Nissan 104254 4244 4.07%

Ford 135782 7400 5.45%

PSA 59983 2747 4.58%

Renault 46448 2841 6.12%

B.M.W. 90962 6901 7.59%

Average 6316 5.31%

In USD million , 2013 Net sales Capital expenditures CAPEX to sales ratio

Volkswagen 197990 12490 6.31%

Toyota 191678 7832 4.09%

Hyundai 76132 2765 3.63%

General Motors 155427 7549 4.86%

Honda 90531 5778 6.38%

Nissan 96072 4915 5.12%

Ford 139369 6600 4.74%

PSA 59349 2814 4.74%

Renault 46308 3110 6.72%

B.M.W. 86049 7592 8.82%

Average 6145 5.54%

Source: Compiled by author / Annual reports of stated companies

In order to make different income statements comparable all figures have been transferred into USD

using the following exchange rates available at www.x-rates.com on 13.04.2016:

EUR/USD 1.131350

JPY/USD 0.009165

KRW/USD 0.000872


101

Appendix 5: CAPEX of Tesla Motors

In USD million Net sales Capital expenditures CAPEX to sales ratio

2013 1922 264 13.75%

2014 3007 970 32.25%

2015 3741 1630 43.57%

Source: Compiled by author / Tesla Motors Annual Report 2015

Appendix 6: World Motor Vehicle Production


Appendix 7: World Passenger Car Production

Year 2009

Manufacturer Passenger cars s s^2 Manufacturer Passenger cars s s^2

Toyota 6148794 12.04 144.93 Tata 376514 0.74 0.54

Volkswagen 5902583 11.56 133.55 Saic 347598 0.68 0.46

G.M. 4997824 9.79 95.75 Anhui Jianghuai 336979 0.66 0.44

Hyundai 4222532 8.27 68.35 Geely 330275 0.65 0.42

Honda 2984011 5.84 34.13 Brilliance 314189 0.62 0.38

Ford 2952026 5.78 33.41 Avtovaz 294737 0.58 0.33

PSA 2769902 5.42 29.41 Great Wall 226560 0.44 0.20

(15,00)

(10,00)

(5,00)

-

5,00

10,00

15,00

20,00

25,00

30,00

0

10000000

20000000

30000000

40000000

50000000

60000000

70000000

80000000

90000000

100000000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

World Motor Vehicle production

Total production % change


102

Nissan 2381260 4.66 21.74 Chrysler 211160 0.41 0.17

Suzuki 2103553 4.12 16.96 Shangdong 169023 0.33 0.11

Renault 2044106 4.00 16.02 Mahindra 145977 0.29 0.08

Fiat 1958021 3.83 14.70 Proton 129741 0.25 0.06

Chana 1525777 2.99 8.92 Chongquing 104434 0.20 0.04

BMW 1258417 2.46 6.07 Fujian 103171 0.20 0.04

Daimler 1055169 2.07 4.27 Kuozui 88801 0.17 0.03

Mazda 920892 1.80 3.25 Porsche 75637 0.15 0.02

Mitsubishi 715773 1.40 1.96 Ziyang 72470 0.14 0.02

Beijing Automotive 684534 1.34 1.80 Guangzhou 62990 0.12 0.02

Dongfeng Motor 663262 1.30 1.69 Chenzhou 51008 0.10 0.01

FAW 650275 1.27 1.62 Qingling Motor 50120 0.10 0.01

Chery 508567 1.00 0.99 Hebei Zhongxing 48173 0.09 0.01

Fuji 440229 0.86 0.74 GAZ 2161 0.00 0.00

BYD 427732 0.84 0.70 Total 51075480

Herfindahl-Hirschman Index [1] 644.35

Year 2014

Manufacturer Passenger cars s s^2 Manufacturer Passenger cars s s^2

Volkswagen 9766293 13.55 183.64 Baic 538027 0.75 0.56

Toyota 8788018 12.19 148.69 Iran Khodro 493585 0.68 0.47

Hyundai 7628779 10.59 112.05 Chery 449333 0.62 0.39

G.M. 6643030 9.22 84.96 BYD 433718 0.60 0.36

Honda 4478123 6.21 38.61 Faw 391079 0.54 0.29

Nissan 4279030 5.94 35.25 Avtovaz 381964 0.53 0.28

Ford 3230842 4.48 20.10 Mahindra 372637 0.52 0.27

Suzuki 2543077 3.53 12.45 Saipa 346914 0.48 0.23

PSA 2521833 3.50 12.24 Brilliance 235115 0.33 0.11

Renault 2398555 3.33 11.08 Jac 196777 0.27 0.07

B.M.W. 2165566 3.00 9.03 Hunan Jiangnan 167522 0.23 0.05

Fiat 1904618 2.64 6.98 Guangzhou 161334 0.22 0.05

Daimler AG 1808125 2.51 6.29 Chongqing 148452 0.21 0.04

SAIC 1769837 2.46 6.03 Haima Cars 93934 0.13 0.02


103

Mazda 1261521 1.75 3.06 Proton 93840 0.13 0.02

Mitsubishi 1199823 1.66 2.77 Guihang 63724 0.09 0.01

Changan 1089179 1.51 2.28 South East 56256 0.08 0.01

Geely 890652 1.24 1.53 Rongcheng 54079 0.08 0.01

Fuji 888812 1.23 1.52 Uaz 25356 0.04 0.00

Dongfeng 745765 1.03 1.07 Ashok Leyland 430 0.00 0.00

Tata 614247 0.85 0.73 Shannxi 109 0.00 0.00

Great Wall 610023 0.85 0.72 Total 72068994

Herfindahl-Hirschman Index 704.33

[1] Herfindahl-Hirschman Index (HHI) =∑ 𝑠𝑖2𝑁

𝑖=1 , where 𝑠𝑖 is the market share of firm 𝑖 in the market, and N is the number of firms.


Appendix 8: Comparative Industry Structure Analysis [1]

Rivalry Substitute threat Buyer power Supplier power Entry threat

Time 0 2.5 2.5 3 2 2.5

Time + 5 1.5 2 2 1.5 2

[1] High=1, Moderate=2, Low=3

Appendix 9: Engineer salaries comparison as of 28.04.2016

Min Max Average

Tesla Motors 76000 154000 112222

Volkswagen 73000 88000 79444

Toyota 68000 110000 84592

G.M. 63000 96000 78977

Honda 56000 88000 65408

Ford 65000 108000 89071

Source: Compiled by author / Glassdoor


104

Appendix 10: Research & Development

Tesla

Motors

Net

sales

R&D R&D to Sales

ratio

2013 1922 232 12.07%

2014 3007 465 15.45%

2015 3741 718 19.19%

Volkswagen Net

sales

R&D R&D to Sales

ratio

2013 197990 10186 5.14%

2014 200858 11545 5.75%

Toyota Net

sales

R&D R&D to Sales

ratio

2013 191678 7400 3.86%

2014 222825 8345 3.74%

Hyundai Net

sales

R&D R&D to Sales

ratio

2013 76132 931 1.22%

2014 77832 882 1.13%

General

Motors

Net

sales

R&D R&D to Sales

ratio

2013 155427 7200 4.63%

2014 155929 7400 4.75%

2015 152356 7500 4.92%

Honda Net

sales

R&D R&D to Sales

ratio

2013 90531 5135 5.67%

2014 108536 5812 5.35%

2015 122152 6073 4.97%

Source: Compiled by author / Annual reports of stated companies


105

Appendix 11: Adjusted financial statements of Tesla motors

INCOME STATEMENT

Numbers in USD 1 000

2011 2012 2013 2014 2015

Revenues

Automotive 148568 385699 1921877 3007012 3740973

Services and other 55674 27557 91619 191344 305052

Total revenues 204242 413256 2013496 3198356 4046025

Cost of revenues

Automotive 115482 371658 1483321 2145749 2823302


Total cost of revenues 142647 383189 1557234 2316685 3122522

Gross profit 61595 30067 456262 881671 923503

Operating expenses

Research and development 208981 273978 231976 464700 717900

Selling, general and administrative 104102 150372 285569 603660 922232

Total operating expenses 313083 424350 517545 1068360 1640132

Loss from operations -251488 -394283 -61283 -186689 -716629

Interest income 255 288 189 1126 1508

Interest expense -43 -254 -32934 -100886 -118851

Other income (expense), net -2646 -1828 22602 1813 -41652

Loss before income taxes -253922 -396077 -71426 -284636 -875624

Provision for income taxes 489 136 2588 9404 13039

Net loss -254411 -396213 -74014 -294040 -888663


106

BALANCE SHEET

Numbers in USD 1 000 2011 2012 2013 2014 2015

Cash and cash equivalents 255266 201890 845889 1905713 1196908

Restricted cash and marketable securities 48537 19094 3012 17947 22628

Accounts receivable 9539 26842 49109 226604 168965

Inventory 50082 268504 340355 953675 1277838

Prepaid expenses and other current assets 9414 8438 27574 76134 125229

Total current assets 372838 524768 1265939 3180073 2791568

Operating lease vehicles, net 11757 10071 382425 766744 1791403

Property, plant and equipment, net 298414 552229 738494 1829267 3403334

Restricted cash 8068 5159 6435 11374 31522

Other assets 22371 21963 23637 43209 74633

Total non-current assets 340610 589422 1150991 2650594 5300892

Total assets 713448 1114190 2416930 5830667 8092460

Liabilities and Stockholders' Equity

Accounts payable 56141 303382 303969 777946 916148

Accrued liabilities 32109 39798 108252 268883 422798

Deferred revenue 2345 1905 91882 191651 423961

Resale value guarantees 0 0 0 0 136831

Customer deposits 91761 138 817 163153 257587 283370

Long-term debt and capital leases, current 8983 55 206 7904 611099 633166

Total current liabilities 191339 539108 675160 2107166 2816274

Common stock warrant liability 8838 10692 0 0 0


Long-term debt and capital leases 271165 411460 598974 1818785 2040375

Resale value guarantee 0 0 236299 487879 1293741

Other long-term liabilities 14915 25170 58197 154660 364976

Total non-current liabilities 298064 450382 1074650 2753595 4145197

Total liabilities 489403 989490 1749810 4860761 6961471

Convertible senior notes 0 0 0 58196 42045

Total stockholders' equity 224045 124700 667120 911710 1088944

Total liabilities and stockholders' equity 713448 1114190 2416930 5830667 8092460


107

Appendix 12: Reformulated income statement and balance sheet of Tesla Motors

ANALYTICAL INCOME STATEMENT

Numbers in USD 1 000 2011 2012 2013 2014 2015

Revenues

Automotive 148568 385699 1921877 3007012 3740973


Total revenues 204242 413256 2013496 3198356 4046025

Expenses

Automotive -115482 -371658 -1483321 -2145749 -2823302

Services and other -27165 -11531 -73913 -170936 -299220

Depreciation and amortisation 16919 28825 106083 231931 422590

Research and development -208981 -273978 -231976 -464700 -717900

Selling, general and administrative -104102 -150372 -285569 -603660 -922232

Total expenses -438811 -778714 -1968696 -3153114 -4340064

EBITDA -234569 -365458 44800 45242 -294039

Depreciation and amortisation -16919 -28825 -106083 -231931 -422590

EBIT -251488 -394283 -61283 -186689 -716629

Corporate tax -489 -136 -2588 -9404 -13039

Tax shield -5 -1 -368 -3236 -2368

NOPAT -251982 -394420 -64239 -199329 -732036

Interest income 255 288 189 1126 1508

Interest expense -43 -254 -32934 -100886 -118851

Net interest expense 212 34 -32745 -99760 -117343

Tax shield 0 0 1186 3296 1747

Net interest expense after tax 212 34 -31559 -96464 -115596

Other income (expense), net -2646 -1828 22602 1813 -41652

Tax shield 5 1 -819 -60 620

Net profit after tax (NPAT) -254411 -396213 -74014 -294040 -888663


108

ANALYTICAL BALANCE SHEET

Numbers in USD 1 000 2011 2012 2013 2014 2015

Operating assets and liabilities

Current assets

Accounts receivable 9539 26842 49109 226604 168965

Inventory 50082 268504 340355 953675 1277838

Prepaid expenses and other current assets 9414 8438 27574 76134 125229

Total current assets 69035 303784 417038 1256413 1572032

Current liabilities

Accounts payable 56141 303382 303969 777946 916148

Accrued liabilities 32109 39798 108252 268883 422798


Resale value guarantees 0 0 0 0 136831

Customer deposits 91761 138817 163153 257587 283370

Total current liabilities 182356 483902 667256 1496067 2183108

Net current assets (NWC) -113321 -180118 -250218 -239654 -611076

Δ NWC -66797 -70100 10564 -371422

Non-current assets

Operating lease vehicles, net 11757 10071 382425 766744 1791403

Property, plant and equipment, net 298414 552229 738494 1829267 3403334

Other assets 22371 21963 23637 43209 74633

Total non-current assets 332542 584263 1144556 2639220 5269370

Non-current liabilities


Resale value guarantee 0 0 236299 487879 1293741

Other long-term liabilities 14915 25170 58197 154660 364976

Total non-current liabilities 18061 28230 475676 934810 2104822

Net non-current assets 314481 556033 668880 1704410 3164548

Net operating assets (Invested capital) 201160 375915 418662 1464756 2553472


109

Financing activities

Cash and cash equivalents -255266 -201890 -845889 -1905713 -1196908

Restricted cash and marketable securities -48537 -19094 -3012 -17947 -22628

Restricted cash -8068 -5159 -6435 -11374 -31522

Long-term debt and capital leases, current 8983 55206 7904 611099 633166

Common stock warrant liability 8838 10692 0 0 0

Long-term debt and capital leases 271165 411460 598974 1818785 2040375

Net interest-bearing debt (NIBD) -22885 251215 -248458 494850 1422483

Equity

Convertible senior notes 0 0 0 58196 42045

Total stockholders' equity 224045 124700 667120 911710 1088944

Equity + NIBD (Invested capital) 201160 375915 418662 1464756 2553472


110

Appendix 13: Financial ratios of Tesla Motors

2011 2012 2013 2014 2015

ROE (I*II*III) -114% -318% -11% -30% -79%

Operating efficiency

Gross margin 30% 7% 23% 28% 23%

Net profit margin (I) -125% -96% -4% -9% -22%

Asset use efficiency

Asset turnover ratio (II) 0.51 0.47 1.29 0.82 0.60

Inventory turnover ratio 4.08 1.54 5,92 3.35 3.17

Days sales of inventory 89.50 237.15 61,70 108.83 115.28

Short-term liquidity risk

Current ratio, cash included 1.95 0.97 1.88 1.51 0.99

Quick ratio, cash included 1.69 0.48 1.37 1.06 0.54

Cash burn rate (no. of years) 1.28 0.64 14.76 11.58 1.98

Cash burn rate (no. of months) 15.34 7.70 177.10 138.95 23.78

Long-term liquidity risk

Financial leverage -0.10 2.01 -0.37 0.51 1.26

Solvency ratio 1.11 0.33 1.59 0.66 0.44

Equity multiplier (III) 1.79 7.12 2.34 4.02 6.00


111

Appendix 14: Forecasting assumptions of Tesla Motor

Historical period Explicit forecasting period

(Forecast horizon)

Terminal

period

-4 -3 -2 -1 0 1 2 3 4 5 6

PRO FORMA INCOME STATEMENT

AR growth 160% 398% 56% 24% 89% 125% 60% 28% 19% 4%

S&O / AR 37% 7% 5% 6% 8% 7% 7% 7% 7% 7% 7%

Gross margin 30% 7% 23% 28% 23% 27% 26% 23% 21% 20% 20%

R&D / TR -

102%

-66% -12% -15% -18% -14% -11% -8% -6% -5% -4%

SG&A / TR -51% -36% -14% -19% -23% -17% -13% -10% -8% -6% -5%

D&A / TNCA -5% -5% -9% -9% -8% -7% -7% -7% -7% -7% -7%

Effective tax rate 0% 0% 4% 3% 1% 8% 8% 8% 8% 8% 8%

Effective interest rate 1% 0% -13% 20% 8% 5% 5% 5% 5% 5% 5%

Other income (expense)

/ TR

-1% 0% 1% 0% -1% 0% 0% 0% 0% 0% 0%

PRO FORMA BALANCE SHEET

(Accounts receivable +

OCA) / TR

9% 9% 4% 9% 7% 8% 8% 8% 8% 8% 8%

Inventory 25% 65% 17% 30% 32% 26% 24% 22% 20% 15% 10%

TCL / TR 89% 117% 33% 47% 54% 48% 43% 39% 34% 29% 25%

Operating lease vehicles

/ TR

6% 2% 19% 24% 43% 35% 20% 18% 16% 14% 14%

PP&E / TR 146% 134% 37% 57% 84% 80% 72% 64% 57% 48% 48%

Other assets 11% 5% 1% 1% 2% 1% 1% 1% 1% 1% 1%

Resale value guarantee,

non-current / TR

0% 0% 12% 15% 32% 29% 26% 24% 22% 20% 15%

(Deferred revenue, non-

current + OLL) / TR

9% 7% 12% 14% 20% 18% 16% 15% 14% 12% 12%

AR=Automotive revenue; S&O=Service and other; R&D=Research and development; TR=Total revenue; SG&A=Selling, general and administrative;

D&A=Depreciation and amortisation; TNCA=Total non-current asset; OCA=Other current asset; TCL=Total current liabilities; PP&E=Property, plant

and equipment; OLL=Other long-term liabilities


112

Appendix 15: Automotive sales forecast of Tesla Motors

2015 E 2016 E 2017 E 2018 E 2019 E 2020

Production 51095 109289 233761 500000 704400 927061

Model S, units 50588 72388 132952 105000 77484 46353

Model S, growth 43% 84% -21% -26% -40%

Model X, units 507 36900 71589 70000 63396 46353

Model X, growth 94% -2% -9% -27%

Model 3, units 29220 325000 563520 834355

Model 3, growth 1012% 73% 48%

Deliveries 50658 87840 208867 446752 663520 882529

Model S, units 50452 58047 120839 110590 82987 52579

Model X, units 206 29793 64652 70318 64717 49762

Model 3, units 23376 265844 515816 780188

Average price/unit

In 1000 USD

Model S 73.85 78.73 78.73 78.73 78.73 78.73

Model X 84.30 84.30 84.30 84.30 84.30

Model 3 42.00 41.11 40.19 39.23

Automotive revenue

In 1000 USD

Model S 3725760 4570207 9514065 8707148 6533859 4139738

Model X 15213 2511564 5450133 5927798 5455626 4194906

Model 3 981798 10927998 20730706 30606436

Total automotive revenue 3740973 7081771 15945996 25562943 32720191 38941080

Automotive revenue growth 89% 125% 60% 28% 19%


113

2015 E 2016 E 2017 E 2018 E 2019 E 2020

Average weekly production 979 2095 4480 9583 13500 17767

Model 3, share 50% 65% 80% 90%

Model 3 weekly production 2240 6229 10800 15991

Total Model 3 units 292201 325000 563520 834355

[1]Model 3 production is expected to start in late 2017, thus this number reflects Model 3 production in Q4 2017.

Inflation rates 2017 2018 2019 2020

USA 2.37% 2.54% 2.33% 2.31%

Europe 1.49% 1.64% 1.76% 1.86%

China 2% 2.20% 2.60% 3%

Average inflation rate 1.95% 2.13% 2.23% 2.39%

Appendix 16: Effective interest rate of Tesla Motors

Numbers in USD 1 000 2018

Notes

2019

Notes

2021

Notes

Total

Principal amount 659761 920000 1380000 2959761

Effective interest rates 4.29% 4.89% 5.96%

Interest 28304 44988 82248 155540

Average effective interest rate 5.26%


114

Appendix 17: Pro forma financial statements of Tesla Motors

PRO FORMA INCOME STATEMENT

Numbers in USD 1 000 2015 2016 2017 2018 2019 2020

Revenues

Automotive 3740973 7081771 15945996 25562943 32720567 38941309

Service and other 305052 467919 1053610 1689037 2161967 2572995

Total revenue 4046025 7549690 16999606 27251980 34882535 41514304

Gross profit 923503 2038416 4419898 6267955 7325332 8302861

Expenses

Depreciation and amortisation 418451 635658 1142793 1643025 1881503 1901867

Research and development -717900 -1039804 -1817390 -2261488 -2246938 -2075715

Selling, general and

administrative

-922232 -1283447 -2243235 -2791392 -2773433 -2490858

EBITDA -298178 350823 1502067 2858101 4186464 5638155

Depreciation and amortisation -418451 -635658 -1142793 -1643025 -1881503 -1901867

EBIT -716629 -284835 359273 1215076 2304961 3736287

Corporate tax -13039 22787 -28742 -97206 -184397 -298903

Tax shield -2368 -5980 -10534 -20061 -29050 -29780

NOPAT -732036 -268028 319997 1097809 2091514 3407605

Net interest expense -117343 -74754 -131673 -250760 -363127 -372247

Tax shield 1747 5980 10534 20061 29050 29780

Net financial expenses after tax -115596 -68773 -121139 -230699 -334077 -342468

Other income (expense), net -41652 0 0 0 0 0

Tax shield 620 0 0 0 0 0

Net income -888663 -336802 198858 867110 1757437 3065137


115

PRO FORMA BALANCE SHEET

Numbers in USD 1 000 2015 2016 2017 2018 2019 2020

Accounts receivable & Other current

assets

294194 579240 1304272 2090871 2676315 3185129

Inventory 1277838 1962919 4079906 5995436 6976507 6227146

Total current assets 1572032 2542159 5384177 8086307 9652822 9412274

Total current liabilities 2183108 3623851 7309831 10628272 11860062 12039148

Net current asset (NWC) -611076 -1081692 -1925654 -2541965 -2207240 -2626874

Operating lease vehicles 1739791 2642391 3399921 4905356 5581206 5812003

Property, plant and equipment 3403334 6052398 12181768 17455912 19972185 19926866

Other assets 74633 109961 247600 396925 508065 604656

Total non-current assets 5217758 8804751 15829289 22758194 26061455 26343525

Resale value guarantee, non-current 1293741 2190178 4474254 6507456 7557057 8159694

Deferred revenue, non-current &

Other long-term liabilities 811081 1372953 2804504 4078553 4735947 5113136

Total non-current liabilities 2104822 3563130 7278758 10586009 12293004 13272830

Net non-current assets 3112936 5241621 8550531 12172185 13768451 13070694

Net operating assets (Invested

capital)

2501860 4159929 6624877 9630220 11561211 10443820

Net interest-bearing debt (NIBD) 1422483 2505607 4771697 6909930 7083484 2900956

Total equity and convertible senior

notes

1130989 1654322 1853180 2720290 4477727 7542864

Equity + NIBD (Invested capital) 2553472 4159929 6624877 9630220 11561211 10443820


116

Appendix 18: WACC of Tesla Motors

Numbers in USD 1000 Estimated

current effective

cost per annum

5-year

average

Market-value

weight

After-tax

costs

Weighted

costs

Net long-term financial obligations 1 028 152 102.53% 2.14% 1.97% 2.02%

Net short-term financial obligations -648 711 -64.69% 0.23% 0.21% -0.14%

Total equity 623 352 62.16% 10.86% 10.86% 6.75%

Equity + NIBD (Invested capital) 1 002 793 100.00% 13.22% 13.03% 8.63%

Risk-free rate 2.17%

Beta (b) 1.39

Market risk premium 6.25%

Required rate of return to equity

holders (Re) 10.86%

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