S-1 Journal

The 10 Questions
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Every S-1, decoded through the same 10 questions.

For a Car That Did Not Yet Exist,
He Bet the Company on a $1 Salary

In January 2010, Tesla Motors filed its S-1. Cars shipped to date: 937. Accumulated deficit: $236.4 million. Revenue for the nine months to September 2009: just $93.4 million.

And yet — by that point, Tesla had already secured a $465 million loan from the US government. The money came from the Department of Energy’s Advanced Technology Vehicles Manufacturing program.

What that loan was meant to build was the Model S — a sedan not a single unit of which had yet been mass-produced. The star of the show was a car that did not yet exist.

And Elon Musk — neither the founder nor originally the president — had become CEO in October 2008. He took on the company for a $1 salary and put his own money in: $10.0 million into the 2007 Series D, $20.4 million into the December 2008 bridge convertible note, and more. The man who bet on a car that did not yet exist was carrying the company on his back.

Ten questions. We lay out only what the S-1 says.

Question 1

What is this company, really?

In one line: a company that designs, manufactures, and sells electric vehicles.

The S-1 puts it this way: “We design, manufacture and sell high-performance fully electric vehicles and advanced electric vehicle powertrain components.”

What Tesla sold in 2010 was the Tesla Roadster — the world’s first mass-produced sports car running on lithium-ion batteries. Built on the chassis of the British Lotus Elise, it did 0–60 mph in 3.9 seconds, had a range of 236 miles, and cost $101,500.

But the Roadster was not the goal. The S-1 says it intends to demonstrate the capability to mass-produce “increasingly affordable electric vehicles” over time.

In other words, Tesla’s strategy had three stages: a high-end sports car (the Roadster) to prove the technology; a luxury sedan (the Model S, base price $49,900 after the federal tax credit); and then a mass-market car. The star is the second-stage Model S — a car not a single unit of which had been mass-produced.

The star is the second-stage Model S — a car not a single unit of which had been mass-produced.

Question 2

What does it compete on?

Tesla’s way of competing has four distinctive features.

A proprietary battery-pack design

Tesla’s technical core is the battery pack. The Roadster assembles 6,831 lithium-ion battery cells (the 18650 cells used in laptops) into a proprietary pack structure. Thermal management, charge/discharge management, and safety mechanisms are all designed in-house.

Tesla defines the locus of its technical edge this way:

“

We believe our core intellectual property contained within our electric powertrain will form the foundation for our planned future vehicles.

TESLA S-1 (JAN 2010) — BUSINESS, OUR COMPETITIVE STRENGTHS

In short, the very skill of bundling batteries together is the weapon.

A direct-sales model

The industry norm is to sell through a dealer network. Tesla uses its own showrooms plus online direct sales. It strips out the middleman margin and controls the customer experience itself.

Selling powertrains to others

Tesla supplied its own electric powertrains to other automakers. By this point it was delivering battery packs for the Smart car to Daimler (the parent of Mercedes-Benz).

So Tesla was, at the same time, a company that sold cars and a components supplier for electrification.

The DOE loan (a government backstop)

The S-1 repeatedly mentions the $465 million DOE loan. This is a long-term loan under the Department of Energy’s Advanced Technology Vehicles Manufacturing (ATVM) Program, earmarked for the planned manufacturing facility and powertrain development. It is Tesla riding a framework in which the government backs this sector.

Battery packs, direct sales, powertrain supply, and government financing — four pillars.

Question 3

How big is the market?

Tesla sketches two markets.

What Tesla aims for first is the premium sedan market. The Audi A6, the BMW 5 Series, and the Mercedes E-Class are among the competition. According to CSM Worldwide, as cited in the S-1, that market represented approximately 2.1 million vehicle sales in the United States and Europe in 2008.

But Tesla’s message does not stop at “capture the luxury market.” It sees policy and incentives as something that “will result in significant growth in the market for electric vehicles.”

Per the Frost & Sullivan forecast the S-1 cites, the market for electric-based vehicles — EVs, hybrids, and plug-in hybrids — is expected to grow from approximately 1.75 million units (3% of new vehicles sold) in 2008 to approximately 10.6 million units (14%) by 2015.

Still, as of 2010, the market for pure electric vehicles was all but zero. What Tesla was describing was the story of building a market that did not exist, by itself.

A premium sedan market of roughly 2.1 million cars a year in the US and Europe. The cars Tesla had sold to date: 937.

Against a sedan market of roughly 2.1 million a year, Tesla was showing up with 937 cars.

Question 4

Who actually uses it?

At this point there were two kinds of customer.

Consumers (Roadster buyers): 937 cars shipped cumulatively as of year-end 2009, priced at $101,500, sold in 18 countries. The buyer profile is the wealthy, the tech industry, and early adopters. No individual buyer names are listed.

Powertrain customers (B2B): Daimler AG (supply of battery packs for the Smart EV, plus a $50 million investment via Series E in May 2009, holding 22,427,223 shares).

Daimler is both an investor and a customer. For Tesla, the meaning is validation — proof of its technology. The fact that the world’s oldest automaker recognized Tesla’s battery technology.

The Roadster was bought by 937 wealthy individuals. The powertrain was bought by an automotive giant. Both were people who believed in Tesla’s technology.

937 wealthy individuals and a global automotive giant — both believed in Tesla’s technology.

Question 5

How does it make money?

By design, Tesla has two revenue streams.

Almost the entire amount is Roadster automotive sales (including $7.6 million of ZEV credits). Powertrain battery-pack shipments began in November 2009, and that revenue was not yet booked as of the end of September.

The gross margin for the nine months of 2009 was 8.3%. In other words, selling a $101,500 car yields a gross profit of only about $8,000.

Tesla is aware of this — the S-1 itself concedes that the Roadster’s gross margin remains low.

The real source of future profit is meant to be the Model S — though the S-1 itself warns there is no assurance Tesla will ever achieve a positive gross margin on it.

Prove the technology with the Roadster, make the profit with the Model S — 2010 is the “proof phase.”

Question 6

Are the numbers healthy?

Lay out the numbers.

Revenue for the nine months of 2009 was $93.4 million (full-year 2008 was $14.7 million). But it posted an operating loss of $29.0 million.

Accumulated deficit (since founding) was $236.4 million, and cash at the end of September 2009 was $106.5 million. There is cash on hand, but developing and mass-producing the Model S requires money of an entirely different order. The S-1 states plainly that the continuation of the business depends on the IPO and the DOE loan.

There is the $465 million DOE loan, but it is tied to building the Model S factory and to manufacturing, and cannot be used for working capital. On top of that, the DOE imposes financial covenants. A breach risks a halt to the financing.

“Tesla is a loss-making company” — and, moreover, “a company that cannot mass-produce the Model S without the IPO and the DOE loan.” The IPO is fundraising “to survive.”

The IPO is fundraising “to survive.”

Question 7

Who runs it?

When you talk about Tesla, there is one name you cannot avoid.

Elon Musk (Chairman & CEO)

The Elon Musk Revocable Trust holds 81,067,755 shares as the largest shareholder (over 5%). His own money went into the 2007 Series D ($10.0 million) and the December 2008 bridge convertible note ($20.4 million), among others. He became CEO in October 2008; he had been Chairman since April 2004.

Against a salary of $33,280, he takes only $1 to preserve cash. His other roles include CEO and Chairman of Space Exploration (SpaceX) (since 2002) and Chairman of SolarCity (since 2006). He co-founded PayPal, which eBay acquired in 2002.

Tesla got through 2008 on bridge loans (February $40.2 million, December $40.0 million, both at 10% annual interest). Musk was one of the largest providers of that bridge, contributing $20.4 million in the December tranche alone. The S-1 records his contribution this way:

“

Mr. Musk has contributed significantly and actively to us since our earliest days in April 2004 by recruiting executives and engineers, contributing to the Tesla Roadster’s engineering and design, raising capital for us and bringing investors to us, and raising public awareness of the Company.

TESLA S-1 (JAN 2010) — MANAGEMENT

A $1 salary, one of the largest insider investors — Musk led Tesla with his own money on the line.

JB Straubel (CTO)

An energy engineer out of Stanford. He led the design of the battery pack and powertrain — the technical core.

Deepak Ahuja (CFO)

Fifteen years at Ford Motor Company. A finance professional from the auto industry.

The founding story

The founding story is told as well. Tesla Motors was founded in 2003 by Martin Eberhard and Marc Tarpenning. Musk joined as an investor in 2004 and later took over the company.

What moved Tesla was one man, putting his own money on the line for a $1 salary.

Question 8

Who controls it?

Tesla’s share structure is designed differently from Google’s or Facebook’s.

Tesla does not use a dual-class structure. All stock is Common Stock, one share, one vote. That was not unusual in 2010. Dual-class became the Silicon Valley standard only after Google’s success, in the 2010s.

Musk is the largest shareholder (the Trust holds 81,067,755 shares). But that does not reach a majority. Because there is no dual-class structure, in theory other shareholders could band together and overrule Musk.

The “invisible guardrails” of Daimler and the DOE

Daimler is both a shareholder and a customer. The DOE loan comes with covenants. As a condition of the financing, Tesla is obligated to comply with certain financial standards and a business plan.

In other words, Tesla was a structure led by Musk, but with Daimler and the US government functioning as guardrails.

Tesla went public single-class. There is no mechanism for the founder to monopolize voting power. Instead, Musk’s overwhelming personal investment and will became, in effect, the controlling force.

Musk’s overwhelming personal investment and will became, in effect, the controlling force.

Question 9

What is it afraid of?

Here are the five things Tesla itself says it worries about most.

Zero experience mass-producing the Model S

The most candid risk the S-1 writes is this one.

“

We have no experience to date in high volume manufacturing of our electric vehicles.

TESLA S-1 (JAN 2010) — RISK FACTORS, MANUFACTURING

The Roadster is low-volume production of a few hundred a year. The Model S targets 20,000 a year. That is two orders of magnitude apart.

And the S-1 states plainly: “We have not selected a facility in which to manufacture and assemble our Model S.” Even the factory to house mass production had not been decided at this point.

A shortage of funds

“We may need to raise additional funds and these funds may not be available to us when we need them.”

Cash on hand before the IPO was $106.5 million (end of September). The nine-month operating loss was $29.0 million. If the IPO does not succeed, or if Model S development costs balloon, additional fundraising is needed.

The risk of breaching the DOE loan covenants

The $465 million DOE loan comes with strict covenants. If it fails to meet the financial standards, the financing is halted. In the worst case, full repayment is demanded.

The limits of battery technology

The Risk Factors cite the inherent risks in the safety, lifespan, and performance of lithium-ion batteries.

Batteries degrading, catching fire, falling short on range — each strikes directly at the value of Tesla’s product. As of 2010, EV batteries were a technology still close to “experimental.”

Market skepticism toward electric vehicles themselves

“The market for alternative fuel vehicles is relatively new, rapidly evolving, characterized by rapidly changing technologies…”

The fundamental question is whether consumers will buy electric vehicles at all. In 2010, EV market share was near zero. Against the convenience of gasoline cars (range, charging infrastructure), EVs were clearly inferior.

“Can it build them,” “can it sell them,” “will the money last” — all of it was unproven.

Question 10

What becomes of the money it raises?

Note: This analysis draws only on the facts in the S-1. The final IPO price, the listing date, post-listing share performance and trading demand are not in the filing and fall outside its scope.

Here is the IPO plan as written in the S-1.

The use of proceeds: Model S development and manufacturing preparation, working capital and general corporate purposes, and expansion of stores and service centers. It comes down to one thing. The money raised at IPO is the money to make the Model S real.

At this point, the start of Model S mass production was planned for 2012. Two years from IPO to mass production. In the meantime, Tesla needed to get by on Roadster sales and powertrain supply while standing up the Model S factory with IPO funds and the DOE loan.

The funding structure: an assumed IPO raise of about $200 million, the $465 million DOE loan, and $106.5 million cash on hand — roughly $772 million in total. Note that the $200 million is not a figure from the original S-1: it derives from the S-1/A (June 2010) and its $14–$16 assumed price range. Of this, the DOE loan is tied to the Model S factory and manufacturing and cannot be used freely. The IPO money was the only sizable pool of cash Tesla could deploy at its own discretion.

Tesla went public for “a car that did not yet exist.” Raise $200 million, begin mass production within two years — or the money runs out.

What was written there was a back-to-the-wall funding plan.

In closing

Beyond the ten questions

What Tesla sells is not just “electric vehicles.” With the Roadster it shipped 937 units of the world’s first mass-produced lithium-ion EV, supplied battery packs to Daimler, and turned Daimler into a major shareholder with a $50 million investment. It won a $465 million loan from the US Department of Energy. But the factory to mass-produce the Model S had not yet been selected at the time of this S-1. It is both a components supplier for electrification and a company the government backs as national policy.

But the star of that S-1 is the Model S, not a single unit of which had been mass-produced. It targets 20,000 a year, yet Tesla has no experience in volume production. Gross margin 8.3%, accumulated deficit $236.4 million, a nine-month operating loss of $29.0 million, $106.5 million cash on hand. In the Risk Factors it discloses “can it build them,” “can it sell them,” “will the money last” — all as unproven.

And Elon Musk — neither the founder nor the president — became CEO in October 2008. He led the company for a $1 salary and backed it with his own money, putting $20.4 million into the December bridge convertible note. The Elon Musk Revocable Trust holds 81,067,755 shares as the largest shareholder (over 5%), but it does not reach a majority, and Daimler and the DOE function as de facto guardrails. A company that bet on a car that did not yet exist heads into a two-year, back-to-the-wall stand by raising $200 million at IPO (an assumed figure per the June 2010 S-1/A).

The S-1 says it will build “increasingly affordable electric vehicles” over time. The market expects “an attempt to rewrite the auto industry through electrification.” At the intersection of the two, Tesla sells stock. 937 sports cars and one dream — the starting point that confronts the auto industry with a new option.

Source: All facts are drawn from Tesla Motors, Inc.’s S-1 (accession 0001193125-10-017054, filed 2010-01-29), together with the company’s IPO roadshow presentation and factsheet where noted.