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Elon Musk Is Making The Most Difficult Bet Of His Career

Tesla muskREUTERS

In the past year, Elon Musk has launched rockets into space, challenged federal authorities, and proposed a transcontinental monorail.

But stakes of those campaigns pale in comparison to what’s riding on his new project: the gigafactory.

First announced last fall, the gigafactory is a planned facility that would allow Tesla to manufacture mountains of lithium ion batteries to be used in both Tesla’s electric vehicles, as well as power storage units sold by Tesla’s sister company, SolarCity.

In essence, the fate of both companies will depend on the gigafactory.

Tesla currently gets its batteries from mega manufacturers like Panasonic. To date, the market for electric vehicles has been too confined to allow the cost of batteries to come down. As a result, batteries remain the most expensive part of a Tesla.

Right now, Tesla says its current battery costs are $US200-$300 per kilowatt-hour, although many analysts say it’s closer to $US500 (a gallon of gas equals 33.7 kwh). Through scale alone, the firm hopes the gigafactory will bring down costs by 30%. A $US175 per kWh battery would be “very competitive” with even a mass market vehicle, Langan writes.

At a tech conference hosted by Tesla last week, Musk put things in even more stark terms: The company won’t be able to function at all if it doesn’t build a gigafactory — and will ultimately need hundreds of them.

“We can’t figure out any other way to scale,” the Wall Street Journal’s Cassandra Sweet quoted Musk as saying.

Morgan Stanley’s Adam Jonas says the company has blown through every single chapter of the Tesla bear case book, from gross margins to fires, and even fears that the entire car could be hacked (Teslas now receive real-time security updates). “So far, at least, they have been doing it… doing it pretty well, actually,” he wrote.

But this time may be different, as there seems to be a huge amount of doubt in the industry as to whether Tesla will be able to meet the targets it has set for the gigafactory. “
Most investors we speak with believe such audacious vertical integration is hubris, adding significant risk to the Tesla story,” Jonas wrote in a recent note.

First, the parts on a lithium ion battery most vulnerable to cost reductions don’t exactly align with where Tesla says it can make the most progress. According to Argonne National Lab data cited by UBS’ Colin Langan, more than three-quarters of battery costs are in raw materials alone. So right off the bat, it becomes very difficult to see where you can get a 30% cost savings. “We see Tesla’s ~$175 per kWh target as very challenging,” Langan said. “We believe Argonne’s cost forecast is optimistic and leaves little room for error.”

Here’s the table that visualizes the magnitude of the challenge before Tesla:

Ubs argonne gigafactoryUBS

Meanwhile, the entire status of the project has only been penciled in. On Tesla’s most recent conference call, Musk only said Panasonic had signed a “letter of intent.” And while is the firm is shopping a number of states for the location of the first factory, it has not yet settled on one. Morgan Stanley’s Jonas says there is no precedent for such a huge announcement with so little in place:

A non-binding letter of intent with Panasonic sends the message of ‘we’re talking’. Stands to reason — they have been partners for years now. We can only imagine the intense debate between TSLA and its prospective Gigafactory partners on issues of economic, strategic and technical significance.

And then there’s the expense of the plant itself. The first gigafactory will cost $US5 billion — more than double Tesla’s entire 2013 revenues. Tesla is listing a $US1.6 billion convertible debt offering to help pay for it, with $US800 million of convertible senior notes due in 2019 and $US800 million due in 2021. The 10 million square-foot facility will employ more than 6,000 workers. Groundbreaking is set to come as soon as next month, with production beginning in 2017.

A successful gigafactory could have implications beyond Tesla. Cheaper batteries would further loosen electricity utilities’ grips on homeowners with rooftop solar panels. Right now, most rooftop-paneled homes remain hooked into the local grid because the sun doesn’t always shine — they still need their utility’s juice. But cheaper storage would give homeowners the ability to power their own homes, allowing them to only tap into the grid in emergencies.

It would also prove a boon to the battery industrial complex. In a recent note on Polypore international, William Blair’s Brian Drab said Tesla could account for more than half of earnings for battery materials supplier Polypore by 2020. “Given Tesla’s plan, it is clear the opportunity is enormous,” he wrote.

But Shayle Khan, the senior vice president at GTM Research, says that for now, the solar storage industry (outside of SolarCity) is hoping for the best but is in no way depending on the gigafactory.

“I think it would be folly,” he said. “There’s no location, they won’t be fully online until 2020…I don’t think anyone is relying on this for [their] planning.”

Jonas also still sees a buying opportunity, and Khan says there’s reason to believe batteries are where solar was 10 years ago — still surrounded by doubt, but trending in an inevitable direction.

“Ask somebody who’s been in solar, whether the more ambitious plans for manufacturing, worked out in that industry,” he said. “It didn’t work out for everybody, but the costs have declined faster than anybody predicted.

Bottom line: Not much else matters for this company right now.

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