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This article first appeared on SumZero, the world’s largest research community of buyside investment professionals. In some cases Barron’s edits the research for brevity; professional investors can access the full version of this thesis and tens of thousands of others at SumZero.com.

Disclaimer: The author of this idea and the author’s fund had a position in this security at the time of posting and may trade in and out of this position without informing the SumZero community.

Target price: $890.00

Recent price: $255.68

Timeframe: 2-5 years

Thesis

We believe Tesla will become a leading player in the more than $2 trillion global automotive industry and the recent negative concerns around the company create a great buying opportunity at the current share price. In our view, this 11-year-old American auto maker will likely become the largest auto maker globally by 2035 as Tesla has 1) an outstanding disruptive product portfolio that will drive consumer demand in the near-term, 2) a strong brand as an electric car manufacturer that will drive long-term revenue growth, 3) minimal competitive risk thanks to other disrupted legacy competitors’ inability to adapt from internal combustion engine (ICE) vehicles to electric vehicles, and 4) a competitive cost structure through vertical integration and little need for marketing, which will help Tesla reach above-industry-average margins.

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Why Tesla Is a Great Company

1. Tesla’s long-term growth will be driven by its disruptive, exceptional product portfolio in the near term.

Today, Tesla’s Model S, Model X and Model 3 are by far the best automobiles consumers can purchase among similarly priced options in the market. The current technologies deployed in Tesla’s electric cars are uncontested by those of competitors in terms of driving performance, safety, need of maintenance, etc. For the first half of 2019, Tesla sold 32,000 more cars year over year in the U.S. while the other legacy premium brands in total declined by 22,000 units, which is a true testament to the quality of Tesla’s product.

Tesla is best positioned to be the leader in autonomous driving. Having a large data set is instrumental to the quality and advancement of autonomous driving technology. With currently over 1 billion miles traveled in Autopilot to date, Tesla has a strong advantage over other self-driving AI companies. By comparison, Google’s Waymo reached 10 million autonomous miles in October of 2018.

Proliferation of supporting infrastructure makes Tesla vehicles increasingly more attractive. While range anxiety was historically a concern for EV consumers, it is becoming less of a concern for Tesla owners thanks to an ever-growing Supercharging network. On the contrary, drivers of EVs of other brands still have to rely on publicly available charging stations.

2. Strong brand as the pioneer of electric vehicles will secure long-term growth.

Before discussing further, we would like investors to understand Tesla’s automobile business from a consumer’s perspective. Unlike many other household items, a car reflects the social status of its owner. Therefore, as people care about their status, brand becomes one of the most important factors in the car buyer’s decision process. Just think about how consumers typically choose their new cars. Most consumers only consider a handful of brands regardless of price-quality attractiveness of other models. This is also one of the main reasons why you cannot find a Chinese car on the street in the U.S. or other developed countries. For this same reason, in the late 1980s, the top three Japanese auto makers had to create separate premium brands in order to attract American consumers, namely Acura, Lexus and Infiniti. Those brands, which were strategically incubated under an established auto maker, emerged about three decades ago. Since then, Tesla has been the first new global brand to emerge.

Thanks to the aforementioned disruptive EV technology, Tesla, in just a few years’ time, has earned a luxury car brand image that is comparable to those of premium German brands such as Mercedes-Benz, BMW and Audi.

We believe the brand power of Tesla, as the pioneer of the electric car, will continue to strengthen along with the growth of its business. This will provide a strong moat in a competitive automobile market and will allow Tesla to maintain a favorable market share in the long run.

3. Minimal competitive risk thanks to other legacy competitors’ inability to adapt to the transition of consumer demand from ICE vehicles to EVs.

The $2 trillion global automotive industry is undergoing a massive shift toward electric vehicles. According to an AAA study in 2018, 20% of Americans are likely to buy an EV in the future, up from 15% in 2017.

Unlike the common view in Wall Street, we see little competitive threat from the new and upcoming EV launches of the legacy auto makers for at least the next 10 years. Even in the past, Tesla’s products were not just competing against other EVs but all other cars of similar price range. This is because from a consumers’ perspective, when they are looking for a new car, they are looking for the best “car,” not just the best “EV.” Thus, it is the ICE cars of these legacy auto makers that are doomed to lose market share to EVs, whichleads to cannibalization of ICE vehicles by EVs of these legacy auto makers.

Can the giant legacy auto makers compete?

In 1995 Amazon started selling books online and over the past 20 years, brick-and-mortar retailers clearly understood the importance of e-commerce. However, due to the heavy infrastructure built for decades of offline retail, these large traditional retailers could not compete with the fast-changing consumer demand for online retailing services.

Similarly, as consumer demand for EVs continues to rise, we expect many legacy auto makers to struggle and some laggards in this electrification trend may even go out of business. Unfortunately, for large legacy auto makers who have all been producing ICE cars, the transition to the production of the EVs is challenging given the capital-intensive nature of production, the historical allocation of talent and alliances etc. Further, the skill sets that these companies have gained over the past decades will shift from being an asset to a burden weighing down the transition. Already, this electrification trend has caused many global auto makers to see declines in profits in the last three years.

According to a study by Equilar, the median tenure for CEOs at S&P 500 companies was five years in 2017. Unlike Elon Musk, the largest shareholder of Tesla, who makes decisions for long-term success, CEOs and senior executives of legacy auto makers who are hired hands are more incentivized to run the companies for short-term performance. For example, Volkswagen’s CEO announced in September 2013 that the company would become the leader in electric mobility by 2018. However, the company is still far from meeting that goal.

Furthermore, over time, as some of these legacy auto makers struggle financially, it will affect their brand image, which will have a significant negative impact on their future business.

4. Automation and economies of scale will continue to improve margins, and Tesla, as a pure EV maker, will achieve margins that have never been seen by other ICE auto makers.

Tesla deploys automated machines in the manufacturing of its cars, and therefore benefits from greater economies of scale. Increased sales, coupled with the completion of the Shanghai GigaFactory by the end of 2019 with initial target production rate of 250,000 cars per year, will improve Tesla’s gross margins and overall profitability. This will allowTesla to continue its fast expansion.

Furthermore, the battery is the single largest component of EV production cost. And Tesla, with its best-in-class battery cost and efficiency, and being free of legacy ICE components, allows it to offer the lowest price per mile range.

Currently, Tesla’s gross margin is already nearing 20% at only 3% to 5% of the production volume of legacy auto makers. This compares to the average automotive industry gross margin of 12.5%, mainly from the cost advantage of producing electric vehicles. We expect this gap to widen as Tesla’s margins improve. The fact that Tesla has little need for marketing further expands the margin advantage.

Risks and the Market’s Concerns

Upcoming launches of new EVs of other established brands might put pressure on demand for Tesla cars.

As explained earlier, car consumers don’t choose among EVs but among all cars within their budget. Electric car sales will accelerate, with increasing consumer demand, and cannibalize existing ICE car makers.

Tesla might face default, given more than $9 billion of net debt, recent quarter’s cash burn of $1.6 billion and the current cash level of only $2.2 billion.

As long as the company can prove that its products are in high demand, capital markets will provide capital with no fail. In early May, Tesla raised another $2.7 billion, a mix of debt and equity raise.

Tesla has missed quarterly delivery targets several times, rendering statements from CEO Elon Musk and management less trustworthy.

As long-term investors, we do not focus on quarterly results compared to expectations. Fast growing businesses must build factories, automate manufacturing, expand into new foreign markets, etc. It is reasonable for a pioneer to overestimate targets sometimes. If we look at the bigger picture, in 2018, Tesla produced and delivered almost 250,000 cars; this was more than five times the volume sold three years ago while most other auto makers barely grew for this three-year period.

For the full report, including a valuation discussion and charts, go to SumZero.com.