Blazejeski, William Tesla Buy Recommendation.pdf

7/27/2019 Blazejeski, William Tesla Buy Recommendation.pdf

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William BlazejeskiThis report is published for the trustees and members of theRoland George Investments Program at Stetson University.

The purpose of this report is encourage the consideration of

Tesla Motors, Inc., for inclusion in the George portfolio.

Important disclosures appear at the back of this report

Ticker: TSLA Recommendation: Buy 2250 SharesPrice: $20.43 Price Target: $29.00

Tesla Highlights

Tesla is a silicon-valley based company that designs, manufactures,and sells Electric Vehicles (EVs). It is currently the only automaker

building and selling highway-capable EVs in serial production (as opposed

to prototype or evaluation fleet production) in North America or Europe.

Since its inception in 2003, over 1,200 Roadsters are now driving in 28countries.These vehicles have already clocked in over six million drivingmiles worldwide.

Tesla recently purchased an automotive manufacturing facility inFremont, California, formerly owned by New United Motors

Manufacturing, Inc. (NUMMI) for $42 million. The facility is

approximately 20 miles from the Tesla headquarters in Palo Alto,

California, and has the capability of creating 500k vehicles annually.

Tesla is involved in two strategic relationships with automotive giantsToyota and Daimler.Tesla develops battery packs for Daimlers Smartfortwo, and an agreement was entered into in July initiating thedevelopment of an electric powertrain for the Toyota RAV4. Daimler and

Toyota both have $50 million dollar stakes in the company.

Tesla plans to release the Model S in mid-2012. The !"#$% ' ()$*+$,-$# -" ./()$ 0'123) .$4$56$ 7."8 9:;?:


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TSLA Buy Recommendation

10/13/2010

2

During the Great

Recession of

December 2007- June

2009, one quarter of

consumers net worth

was destroyed as well

as 7 million jobs.

On October 8th

, the

Dow Jones Industrial

Average closed at

11,006.48, its first

close over 11,000 sinceMay 3

rd.

General Motors and

Chrysler are stillmajority owned by the

U.S. government, and

are yet to issue an

initial public offering.

Economic & Market Analysis:

The Economy

According to the National Bureau of Economic Research, the Great Recession that began in

December 2007 officially ended in June 2009, making it the longest economic drawback since theGreat Depression of the 1930s. Although the recession has officially ended, its presence still

lingers, as the U.S. currently faces high unemployment, historically low consumer confidence, and

equally low consumer spending.

Growth during the first three post-recession quarters averaged about 3.5%, but during the past

quarter (the second quarter of 2010), economic expansion in the U.S. slowed to an estimated

1.6%. This slowdown raises concerns that the economy may be heading toward another recession,although the probability for this to occur is low. The second quarter slowdown could be attributed

to multiple non-repeating, unique factors. These include, but are not limited to:

- The expiration of a first-time homebuyer tax credit.

- A distorted employment picture created by temporary Census workers.

- The effect of the sovereign debt crisis in Europe on financial markets.

These events have posed a minor drawback to the continued growth of the U.S. economy, but

most economists still see significant expansion in 2011. It is anticipated that the economy will

continue on its current path of recovery, albeit a slow one, with growth remaining positive for the

foreseeable future.

The Markets

The YTD figures on most major U.S. indices remain positive, with the S&P 500, Dow Jones

Industrial Average, and Nasdaq composite index all up around 5% during mid October, 2010.

Industry leaders for the S&P 500 include Consumer Durables and Capital Goods, while laggards

include the Utilities, Energy, and Health Sectors. (Seeking alpha)

One promising indicator that the market is coming out of a downturn and heading towards more

normalized conditions is the increase in merger and acquisition activity in 2010. This signals that

bargains may be beginning to disappear from the market, and that a bottom may have been

reached. This year weve seen private equity firms swallow up familiar companies such as Burger

King by 3G Capital; the merger of Continental and United, and acquisition offers, with bothtypical and hostile bids, for companies such as Genzyme and Sara Lee.

Industry Analysis:

Tesla belongs to the Auto & Truck Manufacturers industry, which has seen incredibly dramaticchanges over the past two years alone. The high-energy prices of 2003-2008 began to discourageconsumers from purchasing SUVs and other vehicles of low fuel efficiency. These products werethe cash cows of the industry at the time, especially for The Big Three: GM, Ford, and Chrysler.Their focus on these vehicles and their sudden steep decline in sales, in conjunction with the credit

crunch, piling debt, employee obligations, and the recession, forced GM and Chrysler to file forbankruptcy in 2009. After a period of reorganization, both companies emerged smaller, leanercompanies with less debt, less employees, less obligations, and a battered image.

In 2009, a government-sponsored program to stimulate the auto industry and put more efficientvehicles on the road, cash for clunkers, was largely a success. After the expiration of theprogram during the summer of 2009, auto sales for 2010 remained ambiguous to most analysts.Still, two years after the industry has hit rock bottom, U.S. auto sales have trended higher duringthe first two quarters of 2010, with 11 million units sold in the first quarter and 11.3 million in thesecond quarter. This is still below analysts expectations, but this again can be attributed to theunforeseen economic slowdown in the second quarter of 2010.


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The TeslaRoadster canaccelerate 0-60 in3.9 seconds, butcreates 0emissions.

We are past theidea of anenvironmentallyfriendly vehicleneeding to lookdifferent. Peopledont want tosacrifice anything,including style, to

own an efficientcar.-Franz vonHolzhausen

Model S Chief

designer

Company Analysis

What is Tesla?

Tesla is a unique company located in Silicon Valley, centering itself directly in the middle of a

rapidly developing industry at the forefront of electric vehicle technology. The company wasfounded in 2003 by current CEO Elon Musk, also known as the co-founder and largest shareholder

of PayPal during its 2002 sale to eBay, and his involvement with SpaceX, CEO, and Solar City,

also CEO.

Teslas goal is to produce increasingly affordable electric cars to mainstream buyers relentlessly

driving down the cost of EVs. Palo Alto, California-based Tesla has delivered more than 1,200

roadsters to customers in North America, Europe and Asia. Tesla designs, develops, manufactures,

and sells EVs and EV powertrain components.

In 2012, Tesla plans on launching the Model-S, a 5 passenger luxury sedan with a range of up to

300 miles on a single charge, acceleration of 0-60 in 5.6 seconds, and a base price of around ~50k

(after a federal subsidy of $7,500). Tesla also currently develops and sells battery packs for

Daimlerssmartand A-Classelectric vehicles, and is developing an electric version of the Toyota

RAV-4 that is also planned for sale in late 2012.Investment Points:

- The battery packs used in Teslas EVs are more efficient and less expensive to producethan those of competing EVs. By using small lithium cells, a low cost commoditized battery

produced in high volume for consumer electronics, Tesla passes the advantage of a widely

available, low cost product to the purchasers of their vehicles. In comparison to the battery

technology of other EVs, the cost per kWh, which is the unit for nominal energy stored in a

battery pack, is ~$550/kWh for the Tesla Roadster while the cost of competing format prismaticlithium batteries costs $750-100 kWh. Because Tesla is able to produce its vehicles with a lower

kWh, it is able to have more batteries in each pack, in turn making their vehicles capable of asignificantly higher range than those of its competitors. Additionally, for the upcoming Model

S, price per kWh is expected to drop to $300/kWh. This price decrease can be attributed to:

- Economies of scale. Tesla plans to produce 5k Model Ss in 2012 then around 20k peryear thereafter.

- An increase of 44% fuel packing density over the Roadsters battery.- A decrease by 2/3 in the use of rare earth cobalt in the Model S battery pack.

Other EV producers have strayed away from the type of batteries used by Tesla, being that they

are prone to overheating, and can even catch fire. To deal with this issue, Tesla has developed a

liquid cooling system that cools each battery individually during use. This technology is patentedand has yet to be replicated by any competing company. Their battery technology will remain

unique for the time being, although if emulated by another company, Tesla may lose its

competitive advantage.

- Electric vehicles are expected to represent as much as 5-10% of the U.S. auto market by2020. This may seem like a large number, especially when considering about 8 million vehiclesare sold in the U.S. each year, but Tesla only plans on producing 20,000 units per year of their

flagship Model S, on average, after its 2012 release. Additionally, this amounts to less than 2%of sales in the U.S. mid-size luxury sedan segment, a very modest figure. Tesla has manycompetitive advantages in comparison to other companies planning to release electric vehicles,most notably the proven success of their technology in the Tesla Roadster. Many consumers areconfused or wary of purchasing an electric vehicle, and I believe a company with an established,working product using a new technology should reassure these individuals.

- The Model S will increase Teslas profits from $0.1 Billion in 2010 to an estimated $1.8Billion in 2013. This will be the flagship model for Tesla for the next 5 years, and is one of themost exciting, energizing products currently in the EV pipeline, with over 2,800 reservationsalready made.


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- Federal and state governments are encouraging the purchase of EVs in the United States.The U.S. government currently provides tax credits ranging from $2,500 to $7,500 per vehicle,and state governments offer rebates of up to $6,000 in Colorado and up to $20,000 in California,with most U.S. states having similar offerings. Other countries have similar programs as well.

- Tesla was awarded $465 million dollars in low interest loans from the U.S. Department ofEnergy.The interest rate on these loans is 3%, with repayment beginning in the fourth quarter of2012, and total repayment due by the fourth quarter of 2018. This, in conjunction with I.P.O.proceeds, will enable Tesla to develop new products, pay research and developments costs, andretrofit their new auto-manufacturing facility.

- Daimler and Toyota have already invested $50 million dollars each into the company. Theyare also engaged in various present and future partnerships, which will benefit both companies.These deals validate the technology by two of the auto markets biggest names.

- The purchase of the NUMMI plant from Toyota will enable Tesla to produce their vehiclesin house.This will drive long-term profits up and also increase the amount of vehicles Tesla willbe able to produce. The company has hired some of the most talented individuals from the autoindustry to manage assembly of production lines and future production, and, as of now, the allelectric Toyota RAV4 will be produced in there, reducing operating costs.

- Tesla owns and operates all of their dealerships worldwide. By not franchising theirdealerships, the company is able to achieve higher operating margins and be able to bettermanage inventory.

Competitive Positioning

Although many large automakers have plans to release EVs, their time frames are long andmost vehicles are concept cars and not production ready. Tesla has produced a successful, highperformance all electric vehicle for two years now. Its technology is proven in the form of over 1,200

roadsters, clocking in over 8 million driving miles worldwide, with few vehicular issues and only oneminor recall. Even when in comparison to other companys future electric vehicles, Tesla is stillhighly competitive and boasts much better specifications than these other EVs.

Tesla has had low research and development costs compared to other automakers.It developedthe Roadster for only $100 million dollars, and even through the recession negatively influenced itssales, the product became profitable in the 1Q 2010 (it must be noted that this is because theRoadster is not manufactured in house, and is assembled by Lotus.) Research, development, andassembly line production for the Model S is an estimated $400 million, which is incredibly low forthe auto industry.

Luxury High End Vehicle ComparisonMake Model Type Battery

Type

Density(kWh)

(E/P)

Electric Range(miles/charge)

Launch

Date

0-60 MPH

Performance

$

(k)

Audi E-Tron EV Lithium-ion 42/230 154 miles/charge 2012 4.8 sec NA

Fisker Karma PHEV Lithium-ion 20/ NA 50 Feb 2011 6 sec $88k

Nissan GT-4 EV Lithium-ion NA/NA NA NA 3.5 sec $70k

Mercedes SLS EV Lithium-ion 48/392 392 NA 4 sec NA

Tesla Roadster

Model SModel SModel S

EV

EVEVEV

Lithium-ion

Lithium-ionLithium-ionLithium-ion

53/200

42/ NA66 / NA90 / NA

244

160230300

2008

201220122012

3.7 sec

5.6 secNANA

$100k

$49.5kNANA

Source: Company Reports and Company Websites. Note: PHEV Plug-in Hybrid Electric Vehicle


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There are fouranalysts followingTesla on MSNMoney, onerecommendingstrong buy, onemoderate buy, andtwo strong holds, fora rating of 2.25.

Financial Analysis

As a new company, Tesla has to undertake many costs in order to create their products. The

automotive industry is one of the most capital-intensive industries around, and since its inceptionTesla has operated at a loss. After its founding in 2003, Tesla has incurred a $290 million loss;spending $230 million and having only $147 million in total revenues. At the end of March thisyear, Tesla only had $61 million in its accounts.

The D.O.E. loan and Teslas IPO is enough cash for the company to operate and cover all expensesfor two years. Tesla also has significant intellectual property, which makes me believe bankruptcyrisk is low, and that if share prices trended lower, a takeover could even be possible. The companyhas come close to bankruptcy twice before, but because of the leadership of CEO Elon Musk, thisdid not happen.

Valuation Models

Most of TSLAs financial information does not reflect its potential for growth. Teslas stock has a

negative EPS, no P/E, and the company currently does not pay dividends. Also, most of Teslasfuture revenue will come from its Model S sales in late 2012. It is difficult to gauge how investorsentiment will be in a year, with another year before the first Model S is sold. I believe that thecompany does a tremendous job of building excitement for their cars with news and press releases,and that more and more consumers will become interested in buying a Model S as the release datenears.

The Graham & Dodd Model

VL =CA"TL

ns

#

$%

&

'( Graham & Dodd measures the companys liquidation value. I chose this model

because of Teslas aforementioned risks.

VTSLA =$47,304" $25,634

700

#

$% &

'( Teslas current assets total $47.3 million and liabilities are $25.6 million, with

700,000 shares outstanding.

VTSLA =($30.95) This values TSLA at $30.95, making it about 50% undervalued.Residual Income Model

P* =BPS+ROE" k

k" g

#

$%

&

'(BPS

The residual income model measures securities using the companys current bookvalue per share and present value of expected future residual income.

P* = $17 +.61"15%

15% "12%

#

$%

&

'($17

I am using a return on equity of 15%. This is because a 10-year treasury yield iscurrently 2.41%, and my risk premium is 12%. The current book value per share is$17.00; I am anticipating a ROE of 1 for the lifetime of the stock, and a 12%

growth rate. Revenue will increase from $100 million in 2010 to $1.8 billion in2013, but an 1,800% lifetime growth rate is obviously unrealistic.

P* = 280 Using this model, I achieved a fair share price of $280.

P*=$28 I then divided $280 by 10 to reflect the time constraints of our investment (1 yr). At $28.00, Tesla is currently 37% undervalued.

By averaging both models, I came up with a fair value price of $29.47, with a modestprice target of $29.00.


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Investment Risks

Startups face much risk in the market and Tesla is no exception. The company lists many potential

issues that could delay profits or even force the company into bankruptcy. These include:

- Consumers willingness to accept electric vehicles.Teslas growth is highly dependent uponthe adoption by consumers of EVs, and they are thus subject to an elevated risk of anyreduced demand in alternative fuel vehicles, in general, and electric vehicles, in particular.Their business success depends on attracting and retaining a large number of customers. If they

are unable to do so, they will not be able to achieve profitability.

- Any delays in the design, manufacture, launch and financing of the Model S, including inthe build out of the Model Ss manufacturing facility, will incur more costs andfurthermore could harm Teslas business and prospects. This is Teslas first attempt atmass production of any vehicle. Even though Tesla continuously proves itself as a resilientcompany, and having recruited world-class employees and obtained a state of the art

manufacturing facility, risk with the success of the Model S remains high.

- If Tesla is unable to keep up with advances in electric vehicle technology, they may suffera decline in their competitive position. The automotive market is highly competitive, andTesla faces competition from established competitors and expects to face competition fromothers in the future.The investments from Toyota and Daimler do provide some reassurance tothis, though.

- Tesla is highly dependent on their suppliers. A significant number of which are single orlimited source suppliers, and the inability of these suppliers to continue to deliver, or theirrefusal to deliver, necessary components for their vehicles at prices and volumes acceptable tothem would have a material adverse effect on their business, prospects and operating results.

- The company is highly dependent on the services of Chief Executive Officer Elon Musk.He is the entrepreneurial icon of Tesla, and if something were to happen to him, their businesscould suffer. Mr. Musk has a history of selling out of businesses and is currently involved innumerous other projects, although he is currently focused mainly on the success of Tesla.

- Teslas vehicles make use of lithium-ion battery cells, which on rare occasions have beenobserved to catch fire or vent smoke and flame. An October 2010 recall of the TeslaRoadster happened because of this very problem, exposing the public to the risk of thesebatteries.

Recommendation

There are currently no other U.S. auto manufacturing companies completely dedicated to the

development of Electric Vehicles. This is a blossoming industry, and there are many factors thatmake me believe now is the time to invest in this industry. Our nations dependence on oil is forcingour government to have tremendous rebates for electric vehicles. Consumers are becoming moreaware of the environmental impact of fossil fuel-burning modes of transportation. The auto-industryjust went through its biggest turn of events in its 100 year history, which may make room for new,up and coming competitors. Innovation and excitement about the U.S. auto industry has never beenlower, with the exception of Tesla. Finally, after my analysis, the stock is very undervalued and themarket will certainly factor in the sale of the 2012 Tesla in 2011. Because this company is risky, I

believe it should only represent 2% of our portfolio. Our portfolio currently around $2,300,000, Ibelieve we should buy $46,000 dollars worth of TSLA, or 2,250 shares.


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Figure 1: Income Statementin millions

Source: Company Documents, Student Estimates


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Figure 2: Statement of Cash Flowsin millions

Source: Company Documents, Student Estimates


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Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company.The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content

or publication of this report. [The conflict of interest is]Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.Market making:

The author(s) does [not] act as a market maker in the subject companys securities.Ratings guide:

Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater

over the next twelve month period, and recommends that investors take a position above the securitys weight in the S&P 500, or any other relevant index.A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns overthe next twelve months.

Investment Research Challenge and Global Investment Research Challenge Acknowledgement:

[Society Name] Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment ResearchChallenge originally developed by the New York Society of Security Analysts.

Disclaimer:The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, butthe author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to beused as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a

solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with [ SocietyName], CFA Institute or the Global Investment Research Challenge with regard to this companys stock.