Geoffrey Horton

4/30/2013

TESLA MOTORS (TSLA)

COMMON STOCK SHORT PITCH
A brief note on why Elon Musk cant even make you drop your gas guzzler

TABLE OF CONTENTS
Table of Contents
Who are they? ___________________________________________________________________________________ 1 Welcome to the Real-World, Mr. Musk_________________________________________________________ 2 The Oil Boom That Wasnt Supposed to Happen _____________________________________________ 5 A Government Love Affair ______________________________________________________________________ 6 Whats the Trade? _______________________________________________________________________________ 7
Bull Case _________________________________________________________________________________________________ 7 Bear case ________________________________________________________________________________________________ 8 Final Assesment ________________________________________________________________________________________ 9

Your 1Q 2013 (and beyond) Cheat Sheet ____________________________________________________ 10 Appreciation____________________________________________________________________________________ 11

WHO ARE THEY?

Who are they?
Tesla Motors manufacture, sell and service fully electric vehicles (EV), as well as produce and sell powertrain systems. Founded in 2003 by Elon Musk, co-founder of PayPal and CEO of SpaceX, Tesla is a young, but growing leader in the EV space. Teslas first commercially produced vehicle, the Tesla Roadster, was the first federally-compliant EV in the nation. With the ability to go from zero to sixty in 3.9 seconds, while letting you keep your usual driving habits with a long-lasting battery, Tesla helped turn the idea of an EV into a budding industry. Finding a decent response to their first vehicle, Tesla began shipping an electric sedan (Model S) in June 2012 to appeal to a broader audience. Tesla has also announced the upcoming release (late 2014) of the Model X crossover, which will be able to fit seven adults. Furthermore, there has been recent talk of a third generation vehicle in the works, though no detailed information has been released.

Battery Options Est. Range Base Price Delivered as of 12/31/12

Roadster 53kWh 245mi $109K 2,450

Model S 60kWh, 85kWh, 85kWh (Performance Model) 230mi, 300mi, 300mi $70K, $80K, $95K 2,650

Model X 60kWh, 85kWh 230mi, 300mi $70K, $80K N/A

Figure 1: Tesla Motors current and future models12 In addition to selling vehicles, Tesla designs, produces and sells electric powertrain systems to Daimler for their EV series, as well as Toyota for their RAV4 EV. Both companies have done business with Tesla since 2010 and hold a combined 7.8mm shares in the company. Revenue from powertrain systems only accounted for 8.1% of total sales in 2012. Tesla Motors raised nearly $185mm, after fees, from their IPO in June 2010 when the company and insiders sold over 15mm shares. In 2011, Tesla received nearly $230mm from an additional stock offering nearing 8mm shares. There was another follow-on offering in late 2012 when roughly 8mm shares were sold, raising over $220mm in cash. There are approximately 114.5mm shares outstanding and 72.9mm in public float.

1 2

Teslamotors.com Tesla Motors 2012 10-K estimates

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WELCOME TO THE REAL-WORLD, MR. MUSK

Welcome to the Real-World, Mr. Musk
As with any startup in a new industry, cash and a competitive edge become the essential ingredients for survival. As a veteran of Silicon Valley, Mr. Musk knows this and has taken nearly every action to ensure Tesla stays afloat until it can reach profitably. He estimates Tesla will be in a much better fiscal position this year when production of the Model S ramps up, as can already be seen in Q4 2012 revenue results.

millions $ Total Revenues Cost of Goods Sold Gross Profit Gross Margin % Total SG&A Operating Income Net Interest and Other Pre-Tax Profit Income Taxes EPS

Q1 2011 49.03 31.00 18.03 36.8% 65.37 (47.35) 1.49 (48.79) 0.15 (0.51)

Q2 2011 58.17 39.66 18.51 31.8% 77.25 (58.74) 0.07 (58.76) 0.14 (0.60)

Q3 2011 57.67 40.44 17.22 29.9% 81.70 (64.48) 0.59 (64.99) 0.09 (0.63)

Fiscal Quarters Q4 Q1 Q2 Q3 2011 2012 2012 2012 39.38 30.17 26.65 50.10 31.54 19.96 21.89 58.87 7.84 10.21 4.76 8.76 19.9% 33.8% 17.9% 17.5% 88.76 98.97 110.94 99.70 (80.93) (88.76) (106.18) (108.46) 0.50 1.08 (0.69) 2.19 (81.38) (89.81) (105.49) (110.69) 0.11 0.06 0.11 0.12 (0.78) (0.86) (1.00) (1.05)

Q4 2012 306.33 282.48 23.86 7.8% 114.74 (90.88) (0.75) (90.08) (0.15) (0.79)

Figure 2: Q1 2011 through Q4 2012 fiscal results3 As previously mentioned, the rate at which a startup spends cash is an important factor to consider. Since the COGS and R&D budget cause Tesla to run under a negative operating income, raising cash has been the only option recently. The company has sold millions of shares in follow-on offerings, paired with key partners in exchange for stock, and even taken out a $465mm loan with the U.S. DOE (discussed later). Though the offerings have resulted in much need cash, the dilution has been detrimental for balance sheet statistics. Also, the partnership with Toyota has resulted in a deal where Tesla is expected to receive $100mm from Toyota between 2012 and 2014, but the company is limited in the fact that it cannot continue to attract business in this manner. Furthermore, while the DOE loan was useful, it has already been fully drawn on. Tesla is now on the hook to comply with strict and increasing regulatory demands. Another cash option that is available to Tesla comes from their unique way of holding customer reservation deposits. For a customer to get a spot in line to receive a Model S or X, they must pay a $5,000 refundable deposit. Tesla notes that they use these funds for working capital and other general corporate purposes. 4

3 4

Bloomberg Tesla 2012 10-K

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WELCOME TO THE REAL-WORLD, MR. MUSK

As of December 31st, 2012, there were at least 15,000 customer reservations for the Model S. Using simple math and not subtracting how many of those customers may be from Washington where deposits are held in a segregated account, Tesla may have more than $75mm at their disposal simply from Model S reservations. The company started taking deposits for the Model X in February 2012, but there has been no indication of those reservation numbers. Tesla has noted, though, that they are holding $138.8mm in combined Model S and Model X reservation deposits. Looking at the actual sale of vehicles up until December 31st 2012, Tesla has delivered approximately 2,450 Roadsters, produced 3,100 Model S vehicles and have delivered 2,650 of them. Tesla is currently targeting a production rate of 20k Model S vehicles in 2013 and 10-15k Model X vehicles when production begins in 2014. Tesla has recently reached a steady state production rate of 400 vehicles a week, so these goals seem reasonable.

2010 REVENUE
Asia

2012 REVENUE
Asia
Europe

North America
Europe North America

Figure 3: Tesla revenue by region, 2010-20125 Tesla plans to start their European deliveries for the Model S in summer 2013 and Asian deliveries in late 2013. It is important to note the changing dynamic in sales by region, especially as transportation costs are a much larger issue in Europe. Ford recently announced that they expect to reach profitability again in Europe by 2015, giving similar companies international hope. Though the company has only had one quarter of positive operating income, Mr. Musk made a public announcement on April 1st about Tesla reaching full profitability for Q1 2013.6 He said that Tesla sold more than 4,750 model S sedans, easily beating analyst expectations. There was no indication on how Tesla was able to dramatically increase the rate of actual sales. It should be noted, though, that Tesla recently asked numerous customers on the reservation list to configure their cars for delivery or risk losing their product

5 6

Tesla 2010 and 2012 10-K http://www.latimes.com/business/la-fi-hy-autos-tesla-profit-20130402,0,1962678.story

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WELCOME TO THE REAL-WORLD, MR. MUSK

slot and/or their 2012 pricing7. This could become a future tactic to squeeze more cash from depositors, though it could lead to a short-term inflation of vehicle sales.

Figure 4: Q1 2013 Analyst expectations8

7 8

Tesla 2012 10-K Bloomberg

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THE OIL BOOM THAT WASNT SUPPOSED TO HAPPEN

The Oil Boom That Wasnt Supposed to Happen
I think the most important thing is electrification [on the future of automobiles], becausewe have a limited supply of oil. Elon Musk, USA Today interview 4/22/20139

Current estimates show that by 2020, the U.S. could surpass, or come close to, Saudi Arabias oil production levels10. If one of Mr. Musks initial goals in creating Tesla was to set the U.S. on a path to sustainability, then his dreams could seriously be derailed from an overproduction of oil, creating cheaper transportation costs. Though there is not nearly enough data to perform a regression analysis on fuel prices and Roadster/Model S sales, we can only assume that a consumer will choose the options that benefits their pocket the most.

Figure 5: U.S. crude oil production11

Figure 6: U.S. gasoline and diesel prices12

Furthermore, natural gas prices have averaged out to roughly $4 over the past few years, leading many to believe natural gas could be the early savior to gasoline costs. However, a little over 100,000 vehicles in operation today in the U.S. (majority are buses and trucks) use natural gas. This is mainly due to the infrastructure needed to provide the fuel, newer vehicles needing to be installed with natural gas operating systems, as well as the knowledge to service such vehicles.

http://www.usatoday.com/story/money/business/2013/04/17/elon-musk-tesla-spacex-icon/2076641/ http://online.wsj.com/article/SB10001424127887323894704578114492856065064.html 11 http://www.eia.gov/dnav/pet/pet_crd_crpdn_adc_mbbl_m.htm 12 http://www.eia.gov/dnav/pet/pet_pri_gnd_dcus_nus_w.htm

9 10

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A GOVERNMENT LOVE AFFAIR

A Government Love Affair
As part of the American Recovery and Reinvestment Act of 2009 (ARRA), the Department of Energy received $35.2bn to investment in companies that are, laying the foundation for a clean energy economy of the future.13 Recent soured investments such as Solyndra, A123 Sytems and Fisker Automotive have caused a stir within Congress as tax-payer money is seemingly disappearing. Though these loans only represent small slivers of the overall loans, some of which were allocated to NRG Energy, Georgia Power and AREVA, the political outrage could cause Congress to increase the oversight of these loans, or even halt this loan process to devise a solution.

Figure 7: Section 1705 of DOE ARRA loans14 Though Tesla Motors was not part of the ARRA program, the company did receive approval for a $465bn loan in 2010 as part of the ATVM incentive program. The other recipients of this program included Ford ($5.9bn), Nissan ($1.4bn) and Fisker ($529mm). Tesla had fully drawn down their entire loan by the end of August in 2012. In their 2012 10-K, Tesla noted that they had worked with the DOE to amend the funding requirements so that they may be able to make future payments. They had to remove their requirement for a current ratio greater than one in mid-October 2012, reduced their first pre-funding payment by 14.2mm (originally $28.8mm) and pushed it back from mid October 2012 to February 2013, as well as adding in a covenant promising to work with the DOE to create an early repayment plan. Six more financial ratio constraints begin in late 2013 and 2014, all of which Tesla is currently not in line with.

13 14

http://energy.gov/sites/prod/files/RecoveryActSuccess_Jan2012final.pdf U.S. Department of Energy

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WHATS THE TRADE?

Whats the Trade?
BULL CASE
A startup is only as good as its leader, and Tesla has one helluva CEO. Co-founder of PayPal, CEO of SpaceX (where he spends his time every other day) and Chairman of SolarCity, Elon Musk is a hero in the engineering field, as he has been able to convert futuristic fantasies into real-world solutions while still providing value to shareholders. Tesla was the first company to produce and sell a federally-compliant EV in the U.S. and was the first automaker to IPO since Fords IPO in 1956. Elon Musk has a nearly 32% stake in the company. Though the company has yet to show a profit, the recent upward guidance for Q1 2013 by management puts Tesla ahead of its competitors in terms of sales. Number of vehicles sold for the Chevrolet Volt were 4,421 in North America and there were 3,695 deliveries of Nissans Leaf last quarter. Especially with new financing and leasing deals being offered, more people will have access to Teslas vehicles as the U.S. economy continues to improve.

Figure 8: TSLA 1-year stock performance15 The number of reservations has exponentially increased over the years. In 2010, there were 3,400 Model S vehicles reserved, while now there are at least 15,000 reserved. Also, the number of stores and service stations across the U.S. and internationally has grown to 32 and 29, respectively. Furthermore, Tesla has started to build its Supercharger network across the U.S. There are currently three locations, one in California and the other two on the East Coast. These stations allow only Tesla vehicle owners to charge their vehicle, which takes between thirty minutes to an hour.

15

http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=tsla&insttype=&freq=&show=

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WHATS THE TRADE?

Tesla has also done a good job of diversifying its services beyond purely vehicle sales. With over 117 issued patents, 258 pending, that do not begin to expire until 2026, Tesla is proving that, as Mr. Musk has said, it is more of a technology company than an automotive company. While it may be out of the realm of Teslas long term goals, there may be an opportunity in the future for an automotive company to acquire Tesla and its patents so it can use Teslas powertrain systems in their own vehicles. With already agreeing to several lucrative deals with Tesla, Toyota is a possible candidate with approximately 2.8 trillion ($28bn) sitting in cash.

BEAR CASE
With every pipe dream of a new technology comes the realization that the chance of failure is extremely high, especially in an industry that is already littered with cash-rich companies. While Tesla holds the slight competitive edge of EVs that can hold longer charges, its competitors are fighting their way into the space with a mix of Hybrids and EVs. Not only do companies like Ford and Chevrolet offer cheaper models, but they also help relieve consumers fear of running out of an electric charge while away from home.

Figure 9: Hybrid and EV cost comparison16 Despite its freshly minted IPO status, the company has yet to show that it can produce a profit. From an increasingly negative Free Cash Flow, to selling stock to raise cash and bring in new partners, to an increasingly worrisome situation with the DOE, Tesla is in a sticky situation when it comes to funding its future growth. Furthermore, managements ability to use depositors cash to essentially run day-to-day operations could provide serious issues going forward if the rate of reservations decline or there are delays in producing the Model X or third Generation vehicles (Model X has already been delayed by a year). In every 10-K, Tesla has mentioned that California, and possibly other states, has laws that restrict automotive

16

http://www.toyota.com/prius-plug-in/compare.html#compare/summary/35287/33773/34103/35604

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WHATS THE TRADE?

companies from taking customer deposits before vehicles are available to the dealer from the manufacturer. Managements response is that since the DMV has not stopped Tesla from producing or selling vehicles, than everything is rosy. If the DMV were to step in and halt production in California, a tidal wave of lost sales and canceled reservations becomes very possible. In terms of actually selling vehicles, Tesla has run into a number of issues. First, many states regulate the means through which a vehicle can be sold. Just recently, Tesla has been trying to get approval from Texas to directly sell vehicles to consumers in the state without a physical store. Secondly, with the constant increases of a R&D budget, new technologies are constantly be implemented. Though management has said that 2013 R&D will be lower than previous years, the newer vehicles will continue to quickly replace older ones. The latest financial results show that Tesla still has under 1,000 Roadsters in inventory. Performing a comparison with 2010, it appears that it has taken the company nearly two years to rid itself of 950 Roadsters. Even if Tesla has only 500 Roadsters on hand, that easily adds up to over $50mm in inventory that may never be sold. Even though the company has done its best to relieve the anxiety of consumers by offering longer lasting batteries, the costs to rid those fears has become unrealistic. If a customer wants to charge their vehicle at home, it will take roughly 7 hours to fully charge without a high power connection (4.5 hours). If a customer is fortunate enough to live near a Supercharger station, than they will be able to charge up half their battery in a little over 30 minutes. Tesla currently has three Superchargers in operation, and even though they plan to build more throughout the U.S. and Canada, their latest numbers indicate each station costs between $2$5mm. If a customer needs to get their car serviced or needs a new battery, then they will have to jump through a number of hoops to get a fix since there are only 29 service stations across the U.S. Furthermore, the batteries are only expected to be able to hold 60-65% of its initial charge after 7 years or 100K miles. When analyzing the benefits of driving an EV, consumers who are more environmentally conscious will obviously favor this vehicle beyond others. However, with an estimated fuel cost savings of only $1500$1800 per year, and modest national ($7500) and state tax credits, it makes it difficult for a consumer to move past their current vehicle that can get fueled up and serviced practically anywhere.

FINAL ASSESMENT
With a list of growing competitors, bucket of sensitive customers who cancel reservations at the slightest bump in the road, high sticker prices and dry cash reserves, it is hard to justify the valuation that TSLA is trading at. With the average age of vehicles continuing to rise, the length of ownership dropping, brand loyalty remaining strong and the general poor economic condition many American families find themselves in, I find it difficult to see Tesla in the same, individual entity state three to five years down the line.17

17

http://www.experian.com/assets/automotive/brochures/experian-auto-q4-2012-market-trends.pdf

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YOUR 1Q 2013 (AND BEYOND) CHEAT SHEET

Your 1Q 2013 (and beyond) Cheat Sheet
With 1Q results arriving on Wednesday, May 8th, there are a number important statements to watch out for to gauge whether the investment thesis relies intact. Use the bullet point list below to guide your analysis in the 10-Q and in future reports. Have there been any price reductions? Are there any new tax credits? Or, have some disappeared? How many current reservations are there for the Model S and Model X vehicles? What is the amount of cash being held from depositors? Have there been any delays for the Model X vehicle? Are there any estimates on the production date for the third Generation vehicle? When will Tesla start accepting reservations for the third Generation vehicle? Is the production rate for Model S vehicles still on track for 20k vehicles a year? Is R&D continuing to ramp up into the development of the third Generation vehicle? Has the Roadster inventory been depleted or have they been put to use in other areas? Has cash been set aside for future DOE re-payments? Have there been any updates to the DOE loan agreement? How many new Supercharger stations, service centers and dealerships been built? Are there any new deals with Toyota, Daimler or new automotive companies? Any projections on growth in international markets? Any new state or country regulations that result in lost sales or slowed production? Have there been any changes in management or level of ownership?

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APPRECIATION
Appreciation
Thank you for taking a moment to read through my report. Performing deep fundamental analysis on equities is my passion and I love to share my findings with others. While I do my best to provide a broad overview of my investment thesis, I understand that I am young and still have a great deal to learn. Thus, I am always happy to discuss my analysis in further detail.

Sincerely,

Geoffrey Horton

GEOFFREY HORTON INVESTMENT ANALYST

Tel 912.659.0577 Geoffrey.Horton13@gmail.com

Geoffrey Horton is a recent graduate of the Georgia Institute of Technology in Atlanta, Georgia with a B.S. in Industrial and Systems Engineering. While attending Georgia Tech, Geoffrey managed the largest student-run endowment in the nation with AUM exceeding $920,000. He has previously interned at A. Montag & Associates, a buy-side firm in Atlanta, as well as SMB Capital, a propriety trading firm in New York City.

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author to be reliable, but the author does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used 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.

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