This month, as Tesla begins production of its much-anticipated Model 3 automobile, the company’s finances, which seem equally jaw-dropping, vertiginous, and perplexing, have invited serious scrutiny and questions. Its share price has risen to more than $300, giving it a market capitalization of around $50 billion. Such lofty figures have sent investors’ pulses racing.
Much of the reason behind its high share price is predicated on the vision of its founder and CEO, Elon Musk. Even as others carmakers are struggling to cope with the inevitable transition from combustible to electrical engines, Tesla is forging ahead with its ambitious goals. Although Tesla hasn’t revealed any sales figures, reservations of the Model 3 are estimated to be between 400,000 and 500,000. However, skeptics doubt that it will soon meet this quota. Tesla is committed to producing just 20,000 vehicles per month by the end of 2017, and that is assuming production goes smoothly.
Although Tesla has had no difficulty raising billions of dollars in capital to finance its aggressive production targets for the Model 3, it is bleeding money due to high production costs. Citi Research predicts that Tesla’s cash reserve will fall from $4.4 billion in the first quarter of 2017 to $1.1 billion at end of the year. Tesla will likely require additional external financing – perhaps as much $5 billion by next year.
Despite the rate at which it is burning through cash, Tesla’s valuation remains exceptionally high. According to Brent Goldfarb, an associate professor of management and entrepreneurship at the University of Maryland, it has recently surpassed both Ford and General Motors – even though Ford, with earnings of $4.6 billion and sales of more than 5.5 million cars worldwide, is coming off its second-best year in its long history. Tesla, by comparison, has only sold 76,000 cars while losing nearly $1 billion.
The reason for its high valuation, investors argue, is that the emergence of automated technology and high-capacity batteries has created an opportunity for new entrants into the automotive industry. According to this line of thinking, Tesla has anticipated the eventual widespread adoption of both electrical and autonomous vehicles better than anyone else. Tesla is betting that its massive investments in new technologies can help it scale up production and churn out vehicles at a prodigious rate.
Nevertheless, Tesla’s competition is likely to be fierce. The automotive industry is increasingly blurring the lines between traditional manufacturing, at which Ford and GM excel, and the software industry, which falls within the remit of Google, Apple, and others. Tesla will face an immense challenge trying to compete against these behemoths, while simultaneously scaling up the mass production of electrical cars beyond its current capabilities. Tesla is unusual for many successful Silicon Valley companies: it is operating on razor-thin margins and high investment costs. That gives it only a narrow window to succeed.
Brent Goldfarb argues that in order to beat its competitors, Tesla will need to eventually prove why incumbents such as Ford cannot replicate its capabilities, while simultaneously achieving high enough margins to justify its enormous expenditures. As long as investors believe in the notion that the automotive industry can be disrupted by a bold outsider, Tesla will continue to attract enormous capital. And even if it doesn’t quite achieve its ambitious manufacturing goals, it has made an impressive bet that few other companies would ever attempt.