Tesla Motors - Roaring Apple-Style Hype, or a Ground-Breaking Car Maker?

For Tesla Motors’s CEO & founder Elon Musk, 2013 will be a year to remember. This is the first year since the company was founded in 2003 that Tesla Motors has reported a quarterly profit. Mainly for this reason, Tesla shares have taken off this year, breaking through the barrier of $10bn market cap as a listed company in the Nasdaq. 

Tesla Motors has tripled its share price since last March and reached an all-time high of $114 in May. What is behind this remarkable stock market success and what does the Tesla Motors business model represent for the automobile industry?

Tesla Motors was named after Nikola Tesla, a renowned Serbian-American inventor and pioneer in the electricity field, with several remarkable contributions, such as the design of modern AC induction engine, which the company has basically adopted for its vehicles.

Tesla’s, young, charismatic and South African-born founder Elon Musk is an eclectic inventor and business pioneer himself. A self-taught software developer when he was merely a teenager, after completing his studies at university in business and physics, he co-founded Paypal, which he later sold to Internet giant Ebay.

During his studies Musk drew inspiration from Nikola Tesla’s works, nurturing his dream of bringing back the electric car to the masses. After founding Tesla in 2003, he also became involved in the space exploration business with SpaceX and in the solar business with a company called SolarCity.

Unlike most innovators of his generation, Musk had not forgotten that after many decades of dominance from combustion engines, electricity vehicles were among the earliest passengers vehicles. In the 1900s, before powerful internal combustion engines became the mainstay, electric automobiles held several records for speed and distance on land. At the turn of the century, there were more electric than gasoline-powered vehicles and at one point they even out-sold gasoline-powered vehicles, having about 28% of the automobile market share.

A decade ago, Musk decided to enter the electric car industry, because he was convinced that no major car manufacturer would have any serious intentions to build one. He recognised a growth opportunity in a new market and went for it, well aware that the consensus considered it a rather crazy proposition.

In fact, many companies had already failed for decades to accomplish the goal of bringing back EVs to their former splendour. As a stark reminder of such a difficult challenge, Fisker Automotive and Miles Electric Vehicles, two US manufacturers of hybrid and all-electric cars, have recently filed for Chapter 11.

Elon Musk’s intuition was to try a rather different approach. Building a car purely for the purpose of transportation, efficient but with no-frills, would never make the cut. You really had to make it a desirable object, something that would capture customers’ imagination. Such features were notably missing for example, with the GM Impact, to name one of the most promising attempts by a major automobile maker to create an all-EV in the mid-1990s.

Tesla therefore ‘aimed at markets in which rich people could afford to buy a Tesla as a status symbol… third or fourth car’, as former Internet analyst and now popular financial commentator Henry Blodget recently declared.

Elon Musk's strategy therefore started with targeting a niche market, with a high price/high performance Roadster model, produced in low volumes. Once the brand became established, he then ramped up production volumes and targeted a broader high-end market with unit prices from about $70k, the successful sedan Tesla S. This is remarkably lower than the $109k price set for the Roadster. The next step will be in a few years time, to further lower the price point towards an average of $30k-$40k, while significantly ramping up Tesla’s production volumes.

Meanwhile, Musk positioned the company in such a way as to cooperate with Daimler and Toyota Motors (respectively partners with 4,7% and 10%) helping to jointly develop all-EV models or to supply powertrain components.

This partnership strategy left the company in decent financial shape, after a very troubled 2008 when Musk dug deep in his own pockets to manage a serious liquidity problem. Moreover, it elevates Tesla's technology in this industry, while leaving the door open to a takeover down the line, if the company starts to fire on all cylinders.

Another interesting feature of Tesla Motor’s strategy is its challenge to US car dealers by adopting a direct sales model, similar to the Apple stores. For this purpose, three years ago Tesla hired George Blankenship, a former Apple Executive, to help develop Tesla's retail strategy worldwide.

In fact, Elon Musk has no qualms about taking on powerful lobbies, such as car dealers, which benefit from special protection under the law in many US states by not allowing cars to be sold directly by manufacturers.

Similar to Apple in the early stage of development, Tesla’s marketing is unique, in the sense that it relies heavily on word-of-mouth, rather than heavy advertising budgets.

Musk's genius was in his capacity to harness social media, communicating as often as possible and creating a constant buzz around his enterprise. Social media plays a major role behind the success of the Tesla brand, so much so that Musk's omnipresence and easy accessibility to the media have drawn 225k Twitter followers. Quite a lot, given how relatively few cars Tesla is currently selling (roughly 21,000 this year, compared to about 16 million vehicles overall in the USA).

Could Tesla’s business model work in Europe, where incidentally, the EU has just announced its 2020 CO² target of 95 gram/Km for vehicle gas emission?

Firstly, let's keep the Tesla hype in perspective. The all-EV market, similar to the USA, still represents, a very tiny fraction of the entire European automobile market, accounting for roughly 0,23% of all cars currently being sold.

A bounce in all EV sales during the first two months of 2013 got some industry commentators a bit excited, considering also the launch of new models such as Nissan Leaf or Renault Zoe, which should mark a bigger presence of all-EVs in terms of car sales going forward.

Industry leaders such as Carlos Ghosn, CEO of Nissan, have great hopes for all EVs, claiming that by 2020, demand for these types of vehicles will represent about 10% of total demand. In the UK, the Committee on Climate Change, an independent advisor to the government, hopes to see 1,7 million EVs on the road by the same deadline, if the UK is to comply with its greenhouse gas targets.

In theory, all this should augur very well for an electric car manufacturer, but here’s the rub: Tesla Motor is not competing with EVs such as Smart, Nissan Leaf or Renault Zoe for the simple reason that it’s still a luxury carmaker.

Elon Musk himself could not refrain from laughing when asked during an interview with Bloomberg last October, whether he was worried about competition from the likes of BYD (a Chinese automaker, with an array of products including hybrids and all-EVs, which counts Warren Buffett as a major investor). Such is the gap between the Tesla market segment and other EV carmakers.

It is widely noted that this EU agreement (still to be approved by each state member) on stricter emission targets by 2020, is a carefully orchestrated compromise deal by Germany. It is aimed at ensuring that its high-end automobile makers, such as BMW and Daimler, can continue to produce more polluting cars.

The EU deal will not allow the carry-over of supercredits earned before the 2020 deadline, but will maintain retention of the multiplier (a factor which increases the number of supercredits a manufacturer earns for each low emission vehicle it builds).

Essentially, Germany gets to preserve its high-end combustion engine automobile market for longer, while also benefiting from introducing more low emission vehicles.

Given that at this stage Tesla Motors, with its high price point is addressing precisely the segment dominated by German carmakers, it is unlikely that this EU stricter regulation will do much good for them.

More importantly anyway, Tesla's financial resources only allow to prioritize the US market, given its commitment to develop new models and install their 480 superchargers stations network on the US territory.

Tesla Motors indeed opened a handful of stores in Europe, establishing its stores in London, Munich, Milan, Zurich and Paris, together with a few sales reps in other major European cities. In spite of that, it is my opinion that Tesla’s presence in Europe for several years to come will be more symbolic than strategic.

Tesla Motors is making car enthusiasts reel with its eye-catching design and outstanding driving performance. However, well-known issues persist within this car segment, such as affordability, longevity of batteries and anxiety over the distance the car can actually go, these will be hard to dispel.

It is still too early to tell whether all-EVs can really take off and if Tesla can reach its stated goals. But for those thrill seekers who cannot afford to ride the actual Tesla cars, there is a cheaper option: buy Tesla Motors shares at $109 each…

A rollercoaster ride is guaranteed, given its current lofty valuation and high level of speculative short interest in the stock. Whether you are driving a Tesla or owning shares in the company... take my advice: fasten your seat belt!

Eurozone Credit Crunch: a disease still waiting for stronger remedies

The debate on how to tackle the SME credit crunch should not deflect EU focus from resolving structural imbalances and weaknesses within the Eurozone banking system. The calm EU debate over how to improve the economies in the Eurozone does not reflect a sense of urgency, an urgency which dire economic conditions throughout Europe would otherwise suggest.

The relative tranquility in European markets seems to have provided solace to European leaders, to the point of hiding the scent of burning with a strong whiff of complacency.   A recent statement from French President François Hollande regarding the end of the Euro crisis is emblematic in that respect.

Regardless of the Euro-leaders’ lack of meaningful resolve to tackle the dismal Eurozone economy (six consecutive quarters of economic contraction), a generally shared view is that Small & Medium-sized Enterprises (SMEs) seem to be suffering the most from the current conditions.

Growth is still elusive, not only because of widespread austerity measures put in place by European governments, but also because of insufficient credit available to SMEs.

A dearth of bank lending, noticeable even in countries outside the EU such as the UK, seems in strident contrast with the loose monetary policies adopted by central banks, precisely to facilitate the transmission of credit into the economic system.

ECB Chairman Mario Draghi, over the course of the last year, has issued statements in support of lending, with an emphasis on SMEs.  In his view, special attention to SMEs is required, due to the fact that they account for about 75% of employment and some 60% of economic output. Not only that, access to wholesale markets (for example via bond issuance) is hardly an easy option for them.

Recent research from J.P. Morgan, nonetheless, argues that evidence about SME problems and their underlying causes are not self-evident. Their conclusion seems to suggest that SMEs probably don’t deserve preferential treatment vis-à-vis large corporations or households.

According to the Markit PMI data, a number of economic indicators on the biggest economies, indicates that SMEs in Spain and Italy are not obviously under-performing larger firms. In fact, employment and output indices do not show much difference between those two groups. Rather surprisingly, in these two countries small firms are not faring relatively worse than their peers in Germany or France.

On the financing side, the most recent ECB lending survey does not show stricter tightening of lending standards towards SMEs rather than households or large corporations. In terms of funding costs, MFI interest rate statistics highlight that banks in the Eurozone periphery countries charge higher rates than core countries on all loans. However, the spread between small loans and large loans is very high, only in Spain. Access to finance varies across different countries, with strong evidence that in Spain, SMEs are more penalized than large corporations, if compared to the rest of the Eurozone, while in Italy this applies as well, but to a lesser extent.

This study does raise an interesting point with regards to why the ECB should focus on SMEs rather than other categories.  On the other hand, I think drawing the conclusion that SMEs might not deserve more attention than other economic sectors, purely on the basis of a relatively limited statistical data may miss the scope of Draghi’s point of view.

SMEs are inherently riskier borrowers and credit access is structurally more difficult for them to obtain than for larger corporations, who may have access to alternative funding, other than traditional banks loans.

Furthermore, SMEs tend to have a very strong connection with the local territory, probably more so than large corporations. In the last 20 years, the consolidation of the banking industry may have reduced the role of local banks when it comes to the financing of SMEs.

Given current economic conditions, large national banks have to look after their P&L and (especially in the Eurozone periphery) carefully manage their balance sheets, while new EU banking regulations are curbing leverage.

Therefore, given the deleveraging at large banks, without a more coordinated set of policies in favour of SMEs, it could be difficult to mitigate the double wham of weak demand and difficult access to credit.

Draghi’s approach also makes sense when we consider that SMEs are usually more labour intensive than large corporations. Given the size of small ones, supporting them will go a long way towards helping households too, improving overall employment and private consumption.

Nonetheless, having identified a target such as SMEs to focus on does not necessarily provide a straightforward solution to the problem of growth and employment in the Eurozone.

The recent gathering held in Rome last Friday with high ranked Labour and Finance ministers discussing such issues, seems at least to have identified a shared view on several measures to adopt.

While no concrete measures have yet been finalized, discussions revolved around how to improve long-term credit to SMEs, together with the European Investment Bank (EIB) and national state development agencies, such as Italy's Cassa Depositi e Prestiti, France's Caisse des Depots and Germany's KfW.

The 10 billion euros capital increase which took place at the EIB last year could be leveraged to as much as 60 billion euros using its balance sheet as a lending facility. With that in the background, European governments are evaluating several proposals, including issuing special "mini bonds" and securitized loans backed by state members or the EIB.

Other measures are already available to help SMEs, such as loan guarantee programs, but their efficacy could be further enhanced if AECMs (European Association of Mutual Guarantee Societies) were more localised and were provided with additional financial firepower, going forward.

Eurozone state members face a daunting task of promoting alternative access to funding, increasing liquidity and reducing SMEs dependence on traditional bank loans, while at the same time sticking to Germany-led austerity (albeit more relaxed than in previous years).

State members should focus their activity in several directions, in cooperation with all economic entities.

For a start, there should be a coordinated effort between banks and mutual guarantee societies to provide long-term credit facilities to SMEs. Easing funding charges for banks, who provide increased lending to SMEs at cheaper rates would go a long way towards re-connecting the banking system with its customers.

The private sector could benefit from new regulations, which enable the issuance of new capital and incentivise inter-company borrowing. Wholesalers and large traders could leverage their funding by lending to their own customers. The new rules could also include promotion of Venture Capital and the issuance of corporate debentures.

Public administrations in Europe should also tackle the delay of payments to the private sector (Italy’s abysmal record of about 63 bn euros stock of trade credits and advances payable, springs to mind), improving liquidity for many SMEs in a meaningful way.

Clearly, these are only a few examples of specific measures for SMEs, but by no means, the only ones. While they are obviously important, they cannot replace the fundamental role of banks to kick-start economic growth.

I cannot stress enough the importance of the EU delivering sooner rather than later on broader issues regarding the banking industry.

Reforms aimed at restoring trust in the banking system, improving risk evaluation, recapitalizing banks in difficulty and introducing a regulatory framework for supervision of large institutions at the ECB are still lagging.

The timeline for these reforms is still somewhat hazy, due to the difficulty of overcoming political resistance, mainly from Germany, to undertake more courageous measures.

Recent statements from Germany and France seem to hint at delaying direct bank aid from the ESM (European Stability Mechanism). The Finnish Finance minister Urpilainen has also been on record saying that the second phase in banking union will not be easy, highlighting also that the joint EU deposit guarantee is a not a timely issue.

Such inaction speaks volumes on how difficult it is to further advance political integration inside the EU.

 ‘Virtuous’ countries seem to be pushing harder on each state member to adopt pro-growth initiatives and reforms, shunning any increase in the financial burden for the ECB (or its supranational agencies for that matter) necessary to support such policies.

Without a more substantial coordinated effort at the EU level to resolve some of the critical issues which plague the credit system, it is unlikely that small doses of several different medicines will be sufficient to cure the Eurozone credit crunch.

Apple - Don't Show Me The Money... But The Products!

Apple Inc. is not only one of the largest and most iconic corporations in the world. To my eyes, it is also a stockholders’ darling trying to regain its shining reputation. Seems only yesterday that the Apple share price was ripping through new highs for several years in a row, reaching an all-time high of $702 in September 2012 with an astonishing market capitalization in excess of about $658bn. It is hard not to be mesmerized by a 50-fold increase in market capitalization over 12 years.

What happened in the last year or so is all too familiar for those who dabble in tech stocks investing: a sudden recognition that expectations reflected in the stock price were loftier than warranted by the rapidly changing competitive landscape.

As Pimco’s guru Mohamed El-Erian wisely put it, Apple’s brand name got disconnected from reality and valuation, while competitors, particularly in the smartphones and tablets arena, were beginning to catch up.

Following this stark return to reality, investors hammered Apple all the way down to a recent bottom of $385 at the end April. Since then, the share price seems to have stabilized, hovering in a range between $400/$460.

The abundance of news and market commentary on Apple is mind-boggling, which makes it a fascinating story to follow. To a certain extent, all this noise makes it also hard to invest, because with such a wealth of information and commentaries, it is very hard not to assume that everything has already been discounted in the share price.

Nonetheless, when I look back to the most relevant news spanning over the last 12 months about Apple, I cannot help but notice that this company has been on the front pages, mostly for the wrong reasons.

Mega-trials on patent disputes, formal apologies to China for allegedly poor customer service, a botched update of its operating system iOS6, ballooning costs for building a spectacular new headquarters, lawsuits from disgruntled hedge fund shareholders (i.e. David Einhorn) unhappy for the way that Apple's humongous cash pile of $145bn is being managed. If all this was not enough, now the US Congress is investigating its questionable, albeit probably entirely legal tax practices, which allow Apple to lower substantially its tax base through foreign subsidiaries.

The list above could actually go on, but each item covered and dissected ad nauseam by the media, actually brings me to the point I am going to make. Which is precisely that Apple has become more and more a ‘show me the products’ kind of story, differently from most other stocks that tend to be (to paraphrase Jerry Maguire) ‘show me the money’ stories.

It is obvious to all investors that Apple is still generating a spectacular level of profitability, despite a contraction of its gross margins from 48% to about 37% in the most recent quarter. That makes it in financial jargon either a ‘value trap’ or a ‘screaming bargain’.

Investors bullish on Apple are pointing out that its cash pile provides a more than adequate buffer to navigate through a transition period, during which new products (new wearable devices or perhaps an iTV) and revamped smartphones and tablets models will bring new life to flagging sales and falling profits (albeit still high). Apple valuation multiples, based on broad consensus estimates, would not be justified, unless the market was not leaning towards the notion that Apple is almost a broken story.

I tend to believe that although the market is not always right, in the case of large capitalisation stocks, it is wise to listen to what the share price is telling us.

The recent rebound in Apple shares has probably more to do with short covering (investors who bet hard on a falling share prices during the 1Q13) based on the view that the 2Q13 and 3Q13 would be weak and new product introduction would be slow or disappointing.

The share price rebound also indicates that the market has favourably received the company’s capital allocation plans, which entail significant debt issuance at low interest rates, expanded share buybacks and increased dividend returns to shareholders.

Now it is time for Apple to deliver again on the ground that really matters for the long term: product innovation.

Apple seems to be losing (at least on the surface) the innovation race against Google, which is far more open to demonstrate its R&D prowess and even more importantly to investors, its flexibility to adapt to the changing tech ecosystem.

Google Glass represents an example of the above reasoning, where it seems that Apple is falling behind in the wearable computing device race. Apple’s CEO Tim Cook is entitled to play down Google Glass as a potential mass-market item, but as a reluctant and always late adopter of any tech gadget, probably even I for one would jump on that product at the right price point.

Samsung’s surging market share in smartphones and tablets, together with the likes of Microsoft, Amazon or resurgent smartphone makers like Nokia, RIM and other Asian OEMs, is pointing to intensifying competition.

Apple’s market share in tablets has already fallen in the 1Q13, from 58% to 39% if compared to a year ago. I would find surprising that the same trend we have seen in smartphones over the last 12 months would not develop in tablets as well.

The new Apple iPhone and a cheaper version to be launched later on this fall will no doubt mitigate market share erosion, but I wonder if these steps are not belated. Most of all, will they answer the main question: can Apple still deliver innovation with must-have products?

It would be simplistic just to point out that nothing has come out of Cupertino in the last 7 months. Apple’s CEO Tim Cook, while delivering somewhat vague promises for new products, appears more at ease steering the ship on financial engineering and tax manoeuver than inspiring the younger generation with cool products.

However, product differentiation is becoming more problematic with the smartphone and tablet mass market. Price seems to drive consumers rather than brand alone, as witnessed by Samsung, with its unparalleled ability to penetrate new markets and product categories. Hence, the urgency for Apple to introduce more rapidly new eye-catching and lower price models in order to be able to compete in emerging markets, if not to gain market share, at least to avoid being marginalized.

My view is that given the progressive decline of PCs, the new frontiers of growth in tech will likely be wearable devices and the transformation of the TV in a multifunction media hub for all portable devices.

It would be wrong to say that Apple will not be able to match Google’s head start in wearable devices, but it could mean they will have to play catch-up, becoming a price taker instead of a price setter. Given that about three- quarters of smart phone features can be performed on wearable devices like Google Glass, it is not hard to imagine that this could be a product enabling us to change the way we communicate in the future, displacing a good portion of smartphones.

On the TV front, it appears to be difficult for Apple to launch an iTV soon enough to avoid that competitors such as Microsoft’s XBox One and Roku will not have a strong presence with their entertainments units and streaming players. By the time that Apple can deliver anything more innovative than its current offering, it could be difficult to make inroads in that market.

History tells us that making money out of television sets is a very difficult proposition. In the last two decades scores of large TV sets makers have not managed to maintain their leadership and/or profitability. It is questionable that Apple can achieve that without launching an earth-breaking new device. Assuming Apple can do that, what will be a meaningful sales volume/market share for their P&L, assuming they will likely address the high-end segment?

In general, it is fair to say that few technology stocks have demonstrated the ability to fend off competition and protect above normal profitability over an extended period of time. When it comes to consumer electronics, the likelihood of that happening is even lower.

Apple under the leadership of Tim Cook seems a very different animal than under enormously revered Steve Jobs. I sense that investors would rather have more clarity on the product front rather than on cash management and taxes before jumping on board again big time. Hedge funds flows seem to indicate a lingering scepticism at best on Apple’s future, judging from the relatively muted money flow in the stock.

If the smart money is still on the fence, I would opine that the average retail investor should take heed from this and wait for the ‘iClouds’ to dissipate, before buying more Apple shares.