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posted: 5/27/2013 5:09 AM

Some see bubble as Tesla value soars

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By The Washington Post

The shares of Tesla Motors have been riding in the fast lane, but are they about to hit a speed bump?

The California-based maker of a luxury electric sedan recently proclaimed its first quarterly profit ever, and the stock has doubled to more than $90 a share in the past month. Its founder and chief executive Elon Musk has a stake worth $2.35 billion and on Twitter he has relished the demolition of investors known as short sellers who bet against Tesla's soaring stock. "Seems to be some stormy weather over in Shortville these days," Musk wrote on April 25.

On Wednesday, Tesla announced that it would raise $830 million in new stock and debt offerings, which it would use to repay ahead of schedule its oft-criticized loan from the Energy Department. Musk said he himself would buy $100 million of the offerings, and the stock climbed still higher in after-hours trading.

But some analysts still say the company's stock price is a bubble on a par with the foamy tech-era stocks. It is selling for 585 times its estimated 2013 earnings.

Moreover, Tesla would have booked a loss without the $68 million sale of special credits created by California regulations that reward makers of "zero emission" vehicles -- a misnomer for cars that rely on electricity generated by power plants that emit greenhouse gases.

One indication that Tesla's stock might be overblown is a comparison with the Fiat Group. Fiat's market capitalization is just short of $8 billion, while Tesla is worth about $10 billion. Yet Fiat sold 1 million cars in the first quarter this year, while Tesla sold 4,900. Fiat, which owns Chrysler, earned $40 million; Tesla -- not counting the sale of regulatory credits -- lost $53 million, or more than $10,000 a car.

Yet automobile analysts are along for the ride with Tesla, whose Model S won Motor Trend's 2013 car of the year honors and a rave review from Consumer Reports. After Tesla's share price zoomed past his target, Morgan Stanley analyst Adam Jonas on Tuesday doubled his price target to $103 a share from $47. Tesla shares closed Wednesday at $84.84 each and were up another 5 percent Thursday morning. (Morgan Stanley is one of the co-managers of the Tesla debt offering.)

The zero-emission vehicle, or ZEV, credits are a key revenue source and have provided more assistance to Tesla than have generous federal incentive programs. California's Air Resources Board has mandated that large volume sellers of cars must altogether meet a minimum quota of 7,500 zero-emission vehicles this year and next. Those who fall short must buy credits from those who produce more than their share.

Tesla's strategy for cars with 200-mile ranges dovetails with the ZEV rules, which say that cars with a 100-mile range get three credits per vehicle while those with a 200-mile range get four. Long-range cars with 15 minute recharging capability get five credits, and Musk has hinted that a new faster recharging device will soon be unveiled.

Rival companies privately lament that they have been effectively subsidizing Tesla. Morgan Stanley's Jonas said in an April 26 report that Tesla made $40.5 million, or $13,900 a car, through the sale of ZEV and other credits to other car companies in 2012. He estimates Tesla could earn $250 million this way in 2013. In the first quarter this year, ZEV credit sales accounted for 12 percent of Tesla revenues, Musk said.

However, Honda, a buyer of credits, now has its electric vehicle for sale, said Menahem Anderman, president of Advanced Automotive Batteries, which reports on the industry. He said that by the end of the year the six major automakers that need to meet the 2013-2014 California mandate will all have their own electric vehicles available.

Musk said in a letter to shareholders that "we expect this to decline significantly in future quarters" and that the price of credits had already fallen. But he said that Tesla plans to have a 25 percent gross profit margin "assuming zero ZEV revenue."

At the moment, that is just one of several uncertainties facing Tesla. J.P. Morgan's auto analysts said in a May 9 report that "we continue to have some concerns regarding the market appeal of a more mass-market electric vehicle" and worry that Tesla could be restricted to the relatively small luxury-car niche. (The Tesla Model S price starts at $62,400 and usually tops $80,000.)

Some experts who believe the stock is overblown say that demand for Tesla cars "could materially wane" after a finite number of "early adopters" -- people who like to buy new technology gadgets for their own interest and enjoyment -- are satisfied.

J.P. Morgan's analysts also said that Tesla "still has its work cut out for it" to meet Musk's gross profit margin target of 25 percent. The gross margin in the first quarter stood at 5.7 percent after excluding ZEV credits. (J.P. Morgan, which also provides services to Tesla, raised its target price to $55.79 from $42 a share.)

Anderman added that Tesla still doesn't have a track record that reliably tells consumers (and investors) how long batteries will last, how much it will cost to service them, or how much that will affect resale value. The company has made some guarantees that could prove costly to deliver.

Analysts also point to some positives signs for Tesla. It lowered costs, produced more cars than expected, hasn't reported major reliability problems and produced battery packs for Toyota and Daimler-Benz. Musk forecasts the sale of 21,000 cars, which would give Tesla nearly 10 percent of the market for passenger cars costing at least as much as Tesla's base price.

The company's major shareholders, after Musk, include Fidelity Investments, Morgan Stanley, Abu Dhabi Water & Electric, and Daimler.

Then there is the Musk factor. Born in South Africa, he made a fortune in Zip2, a firm that sold software for online content, and PayPal. Since then he has founded SpaceX for commercial space flights, Tesla Motors, and SolarCity, which designs, finances and installs solar energy systems.

Like many auto industry executives, Musk has a flare for salesmanship and tweets several times a day. He has introduced generous financing plans, opened up about three dozen spiffy dealerships and fiercely attacked a negative piece about the car's range in The New York Times.

For now, he has prevailed over the naysayers. Tesla has no liquidity problems like those that forced Fisker Automotive to halt production. And its reviews have been good. "So is the Tesla Model S the best car ever?" Consumer Reports asked. "We wrestled with that question long and hard. It comes close."

That sort of enthusiasm is the last thing short sellers want to hear. Short sellers borrow and sell shares of a company and make money if the price falls before they have to return the shares. If the share price rises, however, short sellers often scramble to cover themselves before the price rises even further. When they do that, short sellers can drive a stock price even higher in what is known as a short squeeze.

That might account for part of the recent run-up in Tesla's price. The shares shorted amounted to about a third of the free-floating shares of Tesla as recently as February. It's about 11 percent now.

The short sellers' belief that Tesla's horizons are limited might be proven right -- in the long run.

Anderman said that "in two to four years they can be looking at a stagnant or shrinking market, increased service and warranty costs, and reduced revenue from ZEV credit sales and battery pack sales." But, he said, "in the short [term, it] looks exciting and what they have done so far is brilliant."

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