At the same time, the company’s revenue mix has changed fairly considerably as well. Whereas the company earn a considerable portion of its revenue through development services for other manufacturers prior to 2012, the company has begun to rely less on this source of revenue; it accounts for only 1% of its 2013 revenues. Much of the change in revenue composition can be attributed to the growth in sales of its current flagship product, the Model S, the vast majority of which were sold in North America (though the product was also launched in Europe) and the completion of contracts for development services with various manufacturers.

Tesla Revenue Breakdown, 2010-2013

A company’s return on invested capital (ROIC) is a measure of whether or not it is able to create value for investors. The observation gleaned in determining Tesla’s ROIC, is that it is far below its weighted average cost of capital and therefore, based solely on this measure, value is not being captured for investors.

Return on Invested Capital for Tesla’s investors, 2010-2013.

In evaluating Tesla’s ability to capture value, understanding the context surrounding its fruition and continued operation is key. Tesla is only about 10 years old and went public in 2010. It is unique in that it is a very young company that is attempting to disrupt an industry with many entrenched players whom all have significantly more experience and resources. Tesla’s business model is incredibly innovative relative to its competitors in that it owns and operates its distribution network (stores, galleries, service centres, etc.). Further, the company has thus far only released two vehicles, one of which, the Roadster, was in extremely limited quantities.

However, the company faces many risks. Considering the length to which the economy currently relies upon combustion-engines and hydrocarbons in general, any significant change is a while off. Tesla’s vision for a future of sustainable transport is likely not in the best interest of entrenched parties in the automotive industry. As such, the potential for a competitor with more experience in the industry, greater resources, and a well-established brand to introduce a product that directly competes with Tesla is very worrying. Further, it is possible that Tesla will not be able to execute on its trickle-down strategy and thus, be unable to deliver truly compelling electric vehicles at a price point appealing to the mass-market. Also, Tesla’s recent move away from the development services revenue stream increase the riskiness of the business as the company is effectively putting all its eggs in one basket. If the company’s core business of automotive sales were to experience setbacks, Tesla may not have the ability to continue operations. These, among other risks, are serious considerations for investors to take into account.

That said, not all signs are negative. It is clear that though the company is not currently capturing value for investors, it certainly has ability to do so in the future. This can be seen in the trend of significant revenue growth alongside improving margins and ROIC. Note that the company’s ROIC has increased significantly over the past four years and it is well on its way to delivering a positive return that will likely beat its WACC in the near future. Furthermore, at this early stage in the life of Tesla, capturing value is likely not an expectation for most of its investors. As is the case with most new technologies, the cost initially starts off very high, only to come down over time.

For a fuller picture of a company’s past financial performance, its ability to generate value for customers must also be assessed. One method of doing so is to create a sources of revenue statement, which concludes with how much revenue a company generated as a result of stealing share from competitors. When a company generates revenue through share gains it is attracting customers away from competitors, which would only be possible if the company was offering a more valuable product or service.

Tesla’s Sources of Revenue Statement, 2010-2013

Though Tesla did not generate any revenue from share gain in 2010, a significant portion of the company’s revenue growth in 2011, 2012, and 2013 was the result of share gains, 69%, 93%, and 382% respectively. It should be noted that during 2010 the market grew significantly more than any year since, which is likely the reason for the relatively poor performance with respect to revenues from share gains. The significant share gains in the last several years can be attributed primarily to incredibly successful launch of the Model S. Tesla is not yet an established market participant with an established customer base and thus, the company can only really gain market share, which is only possible if it offers something of value to customers. As production of the Model S ramps up and Tesla introduces new models, it is likely that the trend of considerable share gains will continue.

All in all, though Tesla has yet to post an annual profit, the company’s financial performance shows incredibly positive signs. It has the potential to begin creating value for investors in the very-near future and has shown a consistent ability to create value for customers, which is likely why the company has recently been such a Wall Street darling (its stock gained 325% in 2013). If Tesla is able to improve the efficiency of its operations while continuing to deliver on its value proposition to customers, its future financial performance will likely be very positive. This notion is tested below.

Projected Financial Performance

In order to project Tesla’s future financial performance, several assumptions had to be made, as follows:

Tesla will continue to grow at an incredibly fast pace for the next several years before growth tapers off. This growth expected due in response to the company’s plan to launch several new vehicles (the Model X crossover and its third-generation electric vehicle) and is in line with its strategy to start at the top of the market (the high end) before pushing downwards to the mass market. The company’s recently announced “gigafactory”, which is expected to have the capacity to produce enough batteries for 500,000 vehicles by 2020 (up from 22,477 vehicles manufactured in 2013, per the company’s Q4 2013 Letter to Shareholders), further supports this assumption. Tesla will continue to offer high quality vehicles at a premium price relative to its competitors. Thus, it is assumed that Tesla’s operating margins will be in excess of the industry average, which over the past 4 years has been 8.1% (per Capital IQ). With the significant growth expected of the company (see point 1, above), Tesla’s ability to generate revenues relative to its capital base (its capital turns ratio) will increase over the next several years. The industry average capital turns for the last 4 years of 3.5 (per Capital IQ) was used as a baseline. Tesla will achieve a terminal growth rate of 5.5% based on the growth expected of the company (see point 1, above).

Discounted Cash Flow Valuation vs. Market Value as at December 31, 2013

Based on the assumptions above, we are left with a final valuation of $25 billion. The company’s market value as of December 31, 2013 was $19 billion (note that as of market close on April 14, 2014, Tesla had a market cap of $24 billion). The premium noted is likely as a result of differing assumptions and the release of several pieces of news since December 31, 2013, including the company’s FY2013 financial statements (which beat analyst expectations), the announcement of the company’s planned gigafactory, and so on.

Conditions for Continued Success

At this point we have taken a look at Tesla’s business strategy, its business model, how the company’s business model fits the volume operations pattern, and its past and projected financial performance. Before concluding on whether or not the company really is the car company of tomorrow, we will take a look at the conditions necessary for Tesla to continue to be a success.

In an article for the Harvard Business Review, A.G. Lafley, Roger L. Martin, Jan W. Rifkin, and Nicolaj Siggelkow, suggest that framing a problem as a choice incites action on the part of management rather than having management dwell in describing or analyzing the challenge. Having framed the problem as a choice, the alternatives are analyzed with an eye to the conditions that must exist for their success. (Lafley, Martin, Rifkin, and Siggelkow)

The major issue faced by Tesla is the fact that it currently relies very heavily on one source of revenue: vehicle sales, and that too from one model. The company has explicitly stated that it plans to introduce two new models in the near future, the Model X crossover and its third-generation electric vehicle, which it expects to offer at a lower price point and produce at higher volumes than its previous offerings. However, the company does not have a strong record of launching its products on time or at the price points originally promised as seen in the already late Model X being further delayed to 2015 from 2014 (Souppouris). If the overall economy slumps and Tesla’s premium vehicles are no longer attractive or a competitor launches a satisfactory product at a lower price sooner than Tesla, it could face significant trouble, which could threaten the company’s continued operations if it does not have any other sources of revenue on which to rely.

As a choice, this issue can be framed as follows: should Tesla Motors continue to focus its efforts exclusively on bringing the Model X and a viable mass-market electric vehicle to market or should it attempt to diversify its sources of revenue by leveraging its expertise in the research and development of sustainable technologies to offer lithium ion batteries for sale to other businesses?

The conditions that must exist for either of these options to be successful are detailed below.