This is lengthy piece originally published at investinaire.com and republished here by popular request. Topics covered: FUD artistry and definitions. Battery Safety Generally and Specifically in Relation to Tesla Fuel Cell Vehicles (FCVs) Battery Supply Constraint Myth Giga Factory Implications and Funding Realistic Sales/Production Projections Environmental Credentials GAAP and Non-GAAP Disruptive Technology Defined FUD Artistry As the adage goes, a lawyer who represents himself has a fool for a client. Through setting out to publicly contrast AXPW with TSLA, notorious Tesla detractor John Petersen has in fact succeeded in harming his own interests in AXPW in an almost perfect inverse ratio to the circa 300% YTD gains in TSLA. Presiding as he has over a 2013 hammering of AXPW from a high of $0.37 to $0.11 at the time of writing. A circa 300% drop. With sixteen passionately misleading Tesla-related articles published via Seeking Alpha in 2013 alone (the balance by way of contrast promoting a large private loss-making holding in AXPW), Petersen provides both an extreme example, and a useful one when it comes to analyzing FUD. A definition of FUD. Promoting of FUD (Fear Uncertainty and Doubt) is an inherently dishonest pursuit that differs almost none at all from unlawful defamation (slander and libel). The same motive of causing harm by the publication of falsehood which may or may not be aggravated by malice and/or the desire to gain from another’s loss, is identical. The subtle difference being the use of insinuation and obfuscation in an effort to cause an audience to arrive at the desired defamatory conclusion instead of risking litigation by stating it directly. There are many motives for propagating FUD from jealousy and ignorance to prejudice to politics. Naturally to depress sentiment in a stock in which one is short is an example also. Petersen is seemingly not short Tesla, he is long in a battery Technology (an expensive iteration on the venerable lead acid battery) whose shortcoming are highlighted by the commercial success of Tesla with lithium ion. In my opinion there could barely be a more thoroughly worthless excuse to attack Tesla (repeatedly) than the promotion of AXPW and its commercially unnecessary work with PbC. Varta for example has already cornered the market for start stop batteries with a simple and cheap adaptation of a standard lead acid starter battery, the application for which Axion PbC was considered promising. As far as I can see, the sole redeeming feature of the AXPW recent quarterly reports (a company otherwise engaged for all practical purposes in the business of selling its own shares) is the counterintuitive choice by ePower Engine Systems, Inc that is apparently expending time and resources on trials of the Axion PBC technology, despite the existence of cheaper, better, road-approved and tested alternatives readily available throughout the US and Asia in the lithium ion battery market. It turns out that the game is up on that too. The only supposedly promising customer for Axion’s product is Petersen’s new employer. As a homage to FUD: I wonder if ePower was made aware of the overweening conflict of interest with their new hire before they got “independently advised” to become AXPW’s poster child? Lack of internal consistency is a clear sign of an unreliable premise that is typical of FUD vs fact (it is also not a bad way of rapidly identifying email phishing scams too). Nevertheless FUD even its most disjointed form can still cause the desired level of unease amongst the gullible and attract the unscrupulous support of those with an appetite for bad news. Personally I find the approach employed by Petersen and his fellow FUD artists to be deeply offensive. Firstly the self-serving objectives of FUD are to achieve disinformation at the expense of readers, generally for the personal gain of the author. As such it is inherently abusive, especially when the flow of FUD becomes a protracted torrent (shame on Seeking Alpha for giving this man a voice). Secondly, in the case of TSLA, any harm caused, however trivial, is harm caused to something inherently important. That bothers me and it should bother any editor concerned with upholding standards of integrity. Regards Battery safety in general. The comparative safety bar set by gasoline is not actually very high. Any suggestion to the contrary is FUD. There is literally nobody of an age to drive a car that has not grown up with ever-present warnings of the dangers of gasoline until those warnings have become ordinary common knowledge. No matches or lighters, no smoking, use only approved containers, no cell phone calls at the gas station. Still even the most modern gasoline cars catch fire at an appalling rate. What battery ever obliged you not to pick up a cell phone call while filling a fuel tank in case an RF-induced spark blew up the gas station? A total of 149,386 Ford Escape vehicles are currently in NHTSA recall because of excessive fire risk in the engine or engine compartment as at the 26th November 2013. October 31: 1,558 GM Chevrolet Sonic vehicles from 2013-2014, Recalled for insufficient welds that may cause the fuel tank to come loose from the vehicle. Customers of electric cars, especially Tesla’s electric cars are motivated by a combination of performance and range on top of the benefits great economy, and the evident modernity of no-fuss silent acceleration, convenience of home charging, cleanliness and low maintenance. Performance and range is achieved by low weight aerodynamic construction in combination with relatively low mass / high energy density cells. Tesla’s 265 mile EPA figure is great while 400 mile EPA would be even more attractive. Any suggestion that “safety cells” that max out at around 130 Wh/Kg are of any commercial relevance compared with Tesla’s 250 Wh/Kg NCA is FUD. It is FUD because a regression in range and performance is not what the market wants or expects at all. Regards Fuel Cell Vehicles (FCV's) Fuel cells are even more ridiculous, being able to produce neither competitive energy density nor power density. Most functioning FCV designs currently require that the Fuel Cell be hybridized with a BEV design to provide motive power. The entire fuel cell and hydrogen infrastructure exists to replace the simple act of plugging the car into a more economic and more environmentally benign source of electricity. That remains true even if an environmentally and economically acceptable method of producing and distributing hydrogen was invented. Hydrogen is currently just Pipeline Natural Gas with with the CO2, much of the energy, plus nitrous and sulfurous, mercury and lead byproducts burned off at the production plant. That is truly an environmental abomination. Hydrogen production by electrolysis is a myth absolutely precluded by the economic fact that the electricity required for electrolysis is far better transmitted along wires at light speed directly to the end customer for use in whatever appliance including a BEV. The value of electricity is all but destroyed by the inefficiency of producing hydrogen and then transporting the hydrogen to the customer by road and rail. Unlike the ubiquitous electricity grid there is no hydrogen distribution system to speak of. Finally, the ability to secure homeowners adequately from an explosive hydrogen leak collecting around garage light fittings from a hydrogen FCV parked indoors is absolutely beyond the reasonable expectations of an industry that has spent a century trying and failing to prevent leaks of highly viscous fluids (oil). Hydrogen is nature's leakiest substance, so much so that it can pass directly through an undamaged rubber seal. The hydrogen molecule is half the size of helium (the substance that escapes in a matter of hours directly through the material of a party balloons without need of a hole). An hole big enough to leak a single spec of oil on a garage floor is sufficient to deposit the entire fuel tank of an FCV on the garage ceiling in wait for a flick of the light switch to wipe out the entire home. I can very much understand the petrochemical industry’s desperation to convince investors, regulators and even the public that it has a role to play in ‘green’ energy while carrying on a version of business as usual. Nevertheless the fact remains that pulling hydrocarbons from the ground and burning them in the air (even if one were to burn the carbon here and the hydrogen there) is part of the problem and not part of the solution. An example of a real solution of petrochemical industry gaining a foothold in the green energy economy is offered by Total Oil in diverting oil wealth towards investment in solar (SPWR). Regarding Tesla Fire Safety in Particular. A Panasonic NCA cell (as used by Tesla) is inherently many times safer than gasoline in terms of fire safety. To test that assertion one could simply hold a match next to a cell and to an equal weight of gasoline. If perhaps that is unfair, one could try the same experiment comparing the flammability of the inner components of a cell without its metal can with the same weight of gasoline. Before the match burnt down to the fingers it is possible that the cell components would catch fire. Of course the gasoline would again ignite instantly as expected. Now one might like to argue that it would be an even more fair test if the gasoline was in a little metal can just like the cell components. Then it would be relatively safe and probably also survive the match test. Precisely. Tesla builds thousands of these small-can NCA cells into an advanced and intelligent pack incorporating design elements aimed at preventing energy released from one little can destroying its neighbors. This is an enormous step forwards from both large cell LiFe, and of course a single large tank of gasoline that lacks any kind of compartmentalization, let alone thousands of discrete flame-retardant subunits. Attempts to compartmentalize fuel systems into small units have existed in aviation. In road vehicles at best a gasoline fuel system consists of two fuel tank compartments (BMW 7 series for example - and even those are not fire-walled from each other). It is basically an accepted cost of the convenience and freedom of private road transport to acknowledge that a car, its occupants and its surroundings is a total loss upon the rupture of a fuel tank. It is an area in which physics and mechanical design gives way to insurance. Tesla’s technology offers a far superior deal to vehicle occupants, and in light of the company’s upgrade of its warranty to cover fire-loss, it is not even an insurance consideration with respect to the value of the vehicle. In a recent piece on SA, Petersen attempted to introduce the concept of field failure (a one in several million chance of spontaneous combustion that could occur at the cell level). This is classic FUD, a pseudo-scientific and highly improbable ‘thing’ accompanied by an escalating chain of improbable what-ifs aimed at convincing an audience that a total irrelevance is now cause for warning of a real and present danger. The idea was that owing to the law of large numbers, one of Tesla’s millions of NCA cells could mysteriously and spontaneously erupt into flames. This concept was further exaggerated by juxtaposition to a separate concept of cascade failure of nearest neighboring cells until the end result is catastrophic failure of an entire battery pack and bingo - the insinuation of fear for a spontaneously erupting Model S. Back on planet earth, this is FUD because every Model S pack is specifically designed to handle a single cell failure. Each cell is fused, flame vented and coated in “intumescent” material. This material and its configuration (subject of a Tesla patent) functions to absorb much of the heat of a singe cell failure and to expand and insulate that cell from its neighbor. In other words the entire suggestion of cascade field failure from a single cell source with respect to the Tesla battery pack is FUD. It has of course never happened and the chance of it ever happening is infinitesimally small as a matter of patented design. Clearly if Petersen had stated that a Tesla Model S had a design flaw that made it likely to suffer total loss from a spontaneous fire, a well deserved libel suit would have been mailed to him by return. Unable to state that (because it is untrue) Petersen had hoped to dupe his audience to arrive at the libelous conclusion in error on his behalf. This is the nature of FUD. Conversely gasoline cars are entirely capable of spontaneously catching fire and occasionally as a matter of public record they do so, at home, with resulting loss of life and property because they contain large amounts of volatile and flammable liquid in systems that can leak with age, design fault, manufacturing fault, maintenance fault or traumatic damage adjacent to electrical systems and sources of intense heat (red hot exhaust manifold, catalyzer or turbo) any of which can result in a source of ignition in addition to any external ignition source (hot car parked on dry grass or oily newspapers on a garage floor for example). A Tesla vehicle is a departure from the ordinary because its owner is simply not exposed to this cocktail of “normal” risk factors that belong in the realms of 20th century nostalgia. Not the 21st century for any longer than is strictly necessary. The Petersen mantra that at the cell level ‘batteries are chemistry in a can’ is insulting, not only to the intelligence of readers but to both industry and academia bent on developments relating to advanced lithium ion cells. A tank of gasoline is definitely chemistry in a can. The Tesla NCA cell for example includes at least five safety systems at the cell level. 1. The size of the cell is selected for a quantum of containable energy under failure conditions. 2. The wall thickness is designed for an optimum balance of weight and resistance to rupture under failure conditions. 3. The cell contains a safety valve designed to release fumes and flames upon failure in a controlled direction (towards a flame vent in the case of a Tesla pack). 4. The cell contains a highly developed polymer separator material that remains highly porous to lithium ions in normal operation and is designed to become impenetrable to ions at temperatures exceeding 130 degrees Centigrade thereby shutting down the reaction in the event of an impending thermal runaway. 5. The cell in a Tesla pack is coated in intumescent material to absorb evolved heat and to prevent transmission of heat to adjacent cells to prevent cascade failure. Furthermore the battery pack is compartmentalized, flame vented (away from the passenger compartment) and wired with sensors to trigger safety protocols via the onboard computer to shut down the car and to inform the driver and passengers of the vehicle conditions and appropriate actions to take. With respect to a parked vehicle, the billion to one chance of a single spontaneous cell failure is a non-issue (by design) and a multiple simultaneous and spontaneous cell failures is such an astronomic improbability (trillions to one chance), it is similar to the chance of a Model S owner waking up one morning having spontaneously evolved an extra pair of legs. Naturally all of the above is insufficient to entirely prevent issues with an iron bar smashing the entire structure but to suggest that any of this is dumb chemistry in a can is FUD. An iron bar smashing a gas tank exposes the chemistry to both spark ignition from impact and neighboring heat sources (exhaust system etc) and an endless supply of oxidizer (the air) without any safety systems or warning at all besides the noise of impact and ensuing flames/explosion. As a matter of fact, point source failure that can occur per unit of kWh is much more probable per cell in a large cell. A large format prismatic LiFePO4 cell (20+ Ah typically) is inherently 20/3.1 (645%) more prone to ‘field failure’ owing to manufacturing defect than a Tesla 3.1 Ah cell and typically contains only one of the safety systems detailed above - the fusible separator material. This 645% is moderated by the increased stability of LiFe and greatly exacerbated by the commercial pressure on outbound QC to pass cells containing “minor” defects to the customer owing to the expense of scrapping a large and expensive 20Ah object as opposed to a small and inexpensive 3.1 Ah cell. Out of 20Ah, a QC fail of a 3.1Ah cell leaves circa 16.9Ah that can genuinely be sold as a good QC pass. The technical and commercial considerations are exactly analogous to the production of very large flat-screen televisions verses many small ones, each with customer requirement of zero dead pixels. It is entirely possible to run panel production with one dead pixel per 50” of display when selling 20” displays (75% yield). When selling 50” televisions using the same process, the yield would approach 0%. As a matter of fact, most BEVs designs containing LiFe and LiMn chemistry (BYD, Chevy Volt, Nissan Leaf, Honda, Mitsubishi, Ford etc) incorporate the pack in the traditional location of the exhaust/transmission tunnel and/or in the trunk areas of the vehicle, effectively placing the battery pack in the passenger compartment. Not only does this defeat any possibility of hot-swapping and severely hamper the possibility of end-of life reuse of the battery pack in solar etc, fire-walling large format cells one from the next is also problematic, as is automation of large-format cell pack assembly. Tesla’s small format can-cells are easily treated as a component and these are assembled and welded into packs by a robotic pick and place procedure that is highly scaleable and quality consistent. (See Nat Geo Video for a shot of the robot). Regarding battery supply, the “Giga Factory’ and what it tells us about projections for the business of Tesla (particularly when viewed without FUD goggles). In a recent interview when asked to explain the concept of ‘thinking from first principles’, Elon Musk chose as an example the cost of batteries per kWh. Curiously for the benefit of those that require an analogy to validate an argument, his answer was analogous to the principle demonstrated by SpaceX to produce rockets far closer to the cost of the sum of their parts that received wisdom concerning the market price of rockets would indicate was possible. (As Arianespace et al have discovered to their cost). Musk said in effect: If one were to add up the spot prices on the London Metal Exchange for all of the major cost items required to make an automotive battery cell (nickel, aluminum, cobalt, lithium, copper etc) the cost of those materials adds up to a total of around $80/kWh. Now instead of assuming that the cost of batteries per kWh must be between three and five times this $80 figure because that is the way it always has been, the task is to figure out how to combine those materials at a cost resembling that $80 as closely as possible. In my opinion, this is the take home message regarding the potential of a Tesla Giga Factory: A massive opportunity for a step change in profitability and/or a massive increase in the mass marketability of Tesla electric vehicles. Not a threat of an enormous Capex hurdle that Tesla ‘must overcome to survive’. That is FUD. If there is any threat intended, it is to hold Tesla's battery suppliers feet to the fire to provide cells at a reasonable cost on pain of Tesla turning from reliable customer to dominant competitor in the automotive cell supply arena. Now the question comes, where will the money come from to make such a factory? Curiously the root of the answer lies in the existing battery supply agreements! There are two pertinent agreements with Panasonic. 1. 2011, cell supply for 80,000 vehicles. 2. 2013, 2 Billion cells over 4 years. In round figures, a split of 30:70 in favor of 85kWh vehicles containing 7,000 cells, the balance being 60kWh vehicles each containing approximately 5,000 cells, translates to an average number of cells per vehicle of 6400 cells. This translates to a yield of 312,500 vehicles from 2 billion cells assuming those cells are the same 3.1 Ah cells currently used. If they are the new 4 Ah Panasonic cells, then this 2 billion cells translates to a yield of 403,225 vehicles. These figures build on the original supply agreement for 80,000 vehicles that is not yet exhausted. We know therefore that absent any additional cells from LG and Samsung (or BYD), and without the need for any Giga Factory of any description, between the start of production in 2012 and 2017 to expect a range of between 392,500 and 483,225 vehicles of Model S and Model X standard to be produced. These are the figures above, plus the initial 80,000. We also know from Tesla’s published internal production targets that 2017 production is slated for 200,000 units. We also know that 2013 figures will be in the order of 21,500 units and 2014 production is slated to be in the order of 40,000 units. We have a basic subtraction of 261,500 units (2013, 2014 and 2017) to deduct from a range of 392,500 to 483,225, to give a range of 131,000 to 221,725 units produced in the 24 months spanning 2015 and 2016. We also know that in Q3 2013 Tesla accrued $49 Million in cash after all expenses (expansion, operations and R&D) from the delivery of 5500 vehicles. Between now and 2017 we are looking at the something in the order of 371,000 to 461,725 units (just deducting 21,500 units from the forward looking figures). As a simple multiple this translates to a range of: $49M x 371,000/5500 = $3.3 Billion of free cash flow to $49M x 461,725/5500 = $4.1 Billion of free cash flow. This is assuming that there is no efficiencies of scale to be gained from spreading expansion and operating costs over a very large number of vehicle sales as opposed to a very small number of vehicle sales. In reality that efficiency must at least double to yield profitable free cash flow in the order of $6.6 to 8.2 Billion by 2017. This is naturally ample to fund the $1 Billion cost of completing R&D and prepping NUMMI for the Gen III vehicle by late 2016, especially from a standing start of over $700 M in the bank and growing. This ample source of internally generated funds comes on the basis of cells already under contract with Panasonic and these figures present no difficulty when it comes to budgeting for a $1 ~ $4 Billion 'Giga Factory' also. To suggest that Tesla has a cell-supply constraint that somehow prevents this precise outcome, or even makes it unlikely, is absolutely insupportable FUD. So long as demand for Tesla vehicles ramps ahead of supply continuously (there is nothing to indicate that it will not) then either this outcome will occur, or the threat of it occurring will permit Tesla to arrange exceptional terms with suppliers ongoing. Lithium ion battery manufacturing is not particularly vertically integrated. It is quite wrong to suggest that a future Tesla investment in a cell manufacturing line constrains it to a particular chemistry or even a particular cell format. Vendors exist for each of the components of a cell, anode, cathode, electrolyte, separator, can, valve, welding equipment, testing equipment and so on. On the Q3 call, Tesla made it clear that it owns a considerable proportion of the IP required to optimize the Panasonic NCA cell for its own needs. In addition to which, Tesla is the only company that can make a credible projection of customer demand for very high volumes of electric vehicles to balance the risk of internal or external investment in cell production capacity. Petersen’s assertion that LG and Samsung ‘use different chemistry’ is FUD. There is nothing to prevent Tesla licensing IP and specifying identical materials and methods used in the production of cells it receives from Panasonic (just as Apple is able to use iOS device displays from LG and Sharp interchangeably in accordance with identical specifications). As a footnote, Bank of America’s assertion that TSLA’s current valuation cannot be justified because Tesla would need to produce 348,000 vehicles by 2020 is comedic in light of the ramp up that Tesla and its supplers have committed to. The price is amply justified by 2020 production figures far greater than 348,000 - and a business model proven to be able to raise the funds to do it on internally generated cash. In conclusion, Tesla has demonstrated very considerable wisdom in going with small format high energy-density NCA cells, cornering the global supply market in that technology and engineering a pack to deliver high range and performance and so far perfect passenger safety. Given that Tesla has been able to demonstrate its demand curve and vehicle production capacity to the satisfaction of Panasonic, such that Panasonic has agreed to ramp up cell production capacity to meet Tesla’s requirement for an additional 2 billion cells for the better part of half a million vehicles by 2017, it is quite remarkable that the voice of a few Internet trolls touting a combination of battery supply constraint and overvaluation is given any credence by investors at all. We are clearly looking at a business capable of achieving and equiped for 100% compound annual growth. Environmental Impact FUD. Regards internal inconsistency and obfuscation. Petersen and the like has repeatedly issued forth statements to the effect that Tesla’s battery pack is an environmental fraud, abomination etc. Why? The thoroughly bogus assertion that the carbon footprint of making the pack exceeds the lifetime environmental benefits of driving the vehicle verses gasoline. Petersen goes on to assert that the energy used to charge the vehicle is derived from coal (oil, NG etc). When answered that Tesla vehicles are often charged from Solar, Petersen typically responds with the obfuscation that the vehicles cannot be charged from solar at night. While it is tedious to have to unravel this web of deceit it is probably worth it at least once more. Tesla vehicles and their battery packs are produced in the day time. They are produced in the day time by industries that dominate solar power. Panasonic, LG, Samsung and BYD (major cell manufacturers) also lead the global production of solar cells and panels. Tesla’s sister company Solar City not only provides each Tesla purchaser in the US with the option to install Solar without up front cost, the total MWh energy produced by Solar City installations currently exceeds the total energy required by Tesla for manufacturing operations and for a combination of offsetting and directly supplying the energy consumed by the entire 25,000 (and growing) vehicle fleet. As a current fact (both a snapshot and a trend) the expansion of solar energy exceeds the consumption by BEVs universally. The advance of solar capacity is so intrinsically linked to battery and BEV production in the case of Tesla in particular that it is entirely valid to consider the roll-out of these vehicles to be a child process of solar capacity expansion. In other words, a small subset of the global expansion in solar capacity is absorbed by the production and use of Tesla vehicles. The combination is Carbon-Negative and to the extent that the use of a Tesla vehicle replaces miles driven in an ICE vehicle, the environmental benefits are truly profound. To suggest otherwise is FUD. It is impossible on grounds of internal consistency to argue that overnight charging means that solar charging cannot overcome embedded energy cost of producing an 85 kWh battery pack without conceding the fact that the 85kWh of cells (and the pack) were produced in the day time (by a co-producer of solar panels). The carbon debt of the battery is non existent, to suggest otherwise is also FUD. It is impossible to argue that electricity used in refining metals is not obtainable from solar and hydro. Often it is directly. It is also true that large excavators used in open cast mining are often electrically powered. Direct supply and the principle of carbon offset is entirely applicable right down to the level of mining and refining. Recent announcements of the Solar City ‘DemandLogic’ business installing Tesla-derived battery packs for industrial load-balancing and 24/7 solar is a prelude to final proof of a case that I have made in previous articles regards the end of life use of vehicle packs. The point fully defeats Petersen’s assertions and those of all other FUD artists regards the environmental credentials of Tesla’s battery packs. Example: An 85kWh battery upgraded after three years of use at 15,000 miles per year. Using the EPA figure of 265 miles per 85kWh we have 45,000 miles / 265 miles = just under 170 full charge cycles. The Panasonic NCA cell is theoretically capable of 2,700 charge cycles, leaving 93.7% of the useable life available for ‘DemandLogic’ or 24/7 solar applications. It is a crucial feature of the calculations of all FUD artists on this subject, Petersen included, that this greater than 90% environmental and financial value is put to waste (in a land-fill) contrary to reason, economics and common sense. If one were to accept the existence of common sense and the possibility of foresight on behalf of TSLA and SCTY, on this basis alone, any argument demurring on the environmental benefits of Tesla BEVs is absolute FUD. If and only if the Model S is charged from the average US grid mix, Tesla’s due diligence states that the environmental pay-back is achieved by the Model S vs a Mercedes S Class in 5,000 to 10,000 miles (of a possible greater than 500,000 mile lifespan). In reality considering point 1 above, the car leaves the production line carbon negative. In consideration of point 4 above, even if the battery is produced at night with energy derived from a coal plant and the car is only ever charged at night from a coal plant too, the environmental payback is in the order of 8:1 (i.e. if the whole car manufacturing and use cycle is just a delay before the pack is deployed in a solar array). I am no fan of ad-hominem, however in this case it abundantly clear to the exhaustion of all other possibilities that the only reason to attempt to discredit the environmental credentials of Tesla’s BEVs must rest with the motives of the messenger, the argument against Tesla on this score does not exist in reality. More internal inconsistency. GAAP and non-GAAP FUD. Petersen: ‘The CPA Certificate on my wall says....’. To the best of my knowledge, in strict accordance with GAAP that certificate is a NON-GAAP fairytale due to lack of credits for hours worked in the field of accountancy. Nobody, not even me, would argue the validity of a Non-GAAP CPA certificate when it comes to general knowledge. To misuse that competency to deceive is appalling. Where I take issue is to hold out GAAP lease accounting as an absolute (in the same class as money owed to a bank) despite the factual and obvious contradiction with common sense. There is no debt owed by Tesla in relation to lease accounting, there is a technical delay in recognizing profits that are in the bank. The Tesla lease accounting system requires the company to treat the liability of residual guarantees in the same category as a debt despite the fact that the residual guarantee is exactly what it says in the Tesla Financing contract: A guarantee that has a window of validity between 36 and 39 months from the date of purchase to trade the vehicle with Tesla for a fixed residual price. In accordance with GAAP there is no value recognised for Tesla’s benefit in that trade (the vehicle!) Instead the value of the residual guarantee is treated as a deduction from cash received by Tesla (there is no such deduction in reality). For 2013 vehicles, that window opens and closes in 2016 while in fact 100% of the cash from the sale is banked in 2013. Tesla’s exposure to GAAP lease accounting stems from the fact that Tesla is a participant in the end-user sales of its vehicles. Instead of a dealer making a customer introduction to a lending institution, Tesla does so. Tesla benefits from the finance introduction fee as a result instead of a dealer. This is in addition to the sales price of the vehicle received in cash and in full at the point of sale. As seen above, in 2016 Tesla can be reasonably expected to deliver roughly 80,000~100,000 vehicles (a reasonable proportion of the 131,000 to 221,725 vehicles predicted by cell supply contracts in 2015~2016). 30% of the 2013 US Model S sales are estimated to be assessed under GAAP lease accounting per Q2 earnings call, a figure of around 6,300 vehicles. Residual guarantees are less than 50% of the value of those 6,300 vehicles (in other words less than the full value of 3150 vehicles). 3150/100,000 = 3.15% of 2016 sales at the outer limits of possibility if, and only if, ALL of the residuals are claimed and ALL of those 6,300 vehicles are crushed, reducing them to a value of $0.00. If more realistically only some of the residuals are claimed and the vehicles recovered by Tesla resold (as would naturally be the case), the effect of lease accounting on Tesla’s cash flows in 2016 and onwards will be so close to $0.00 as to be validly dismissed as irrelevant, thereby validating the Non-GAAP figures presented by Tesla which as a matter of fact show a company that is cash flow positive and in profit whilst simultaneously in global hyper-expansion. To suggest otherwise is the most deplorable FUD that can serve only to misinform. It is obviously impossible to reach a right understanding of the Tesla business while treating escalating vehicle sales facilitated by Tesla Financing as an escalating liability (aka debt) owing to the wilful misunderstanding promoted by FUD artists on this topic. There is no such debt and there is no impact on either current 2013 or future 2016 cash flows. For the most part I would expect the majority readers to come to a relationship with money from familiarity with budgeting for home and business where cash is king and there is a clear difference between a debt to be repaid and the possibility of a future purchase of an asset. I can also respect the minority of readers whose belief system would collapse before accepting that a GAAP metric is less real than a non-GAAP metric, even if the non-GAAP metric is demonstrably true to the principle that cash is king and the GAAP metric is not. This minority is called accountants. I would however expect that minority (GAAP Accountants) to be sufficiently sophisticated not to confuse Tesla’s GAAP liabilities with a debt (or to try to confuse others that it is). Clearly in the case of Tesla, GAAP is at odds with common sense when the impression given by GAAP (a loss of $38 million for Q3) meets the hard reality that the bank account grew by $49 million with nothing new owing to any lending entity. It is also non-sensical that the main source of so called “loss” is derived from selling cars at greater than 20% gross profit margin banked in Q3 in cash! The right-minded GAAP interpretation is however equally incredible: This $89 Million ($49 + $38 M discrepancy) is largely composed of not just interest-free but positive interest* working capital with external collateral for lending gifted to Tesla by Tesla’s customers (in the form of customer vehicles upon which the lending is secured). *Positive interest meaning Tesla is actually paid an introduction fee to arrange the “lending” as opposed to an liability to pay interest. Petersen not only states as fact that the company made a $38 million loss (FUD) he goes on to state the company has $1.5 Billion of debt (also FUD). The company's liabilities are primarily to convertible bond holders and in the fantasy of lease accounting treatment of cash-flow positive sales a form of debt as described above. Petersen goes on to allude to the concept of bond-holders leveraging companies into Chapter 11 bankruptcy. This is appallingly inappropriate FUD in the case of Tesla. There is a mechanism by which bond holders can demand cascade quantities of shares in lieu of interest owed in default. However, Tesla can not only amply afford to service its bond obligations at 1.5% interest, it can afford to (and has the right to) repay its bond holders from cash at bank at any time since the bonds were issued, and far from burning through the cash raised from the sale of bonds, Tesla’s bank balance is growing during and despite R&D and hyper-expansion of sales, service and Supercharging infrastructure across the US, Europe and Asia. To suggest Tesla is exposed to defaulting on its bond holders is FUD verging on fraud. In the absence of FUD a picture emerges that is extraordinary from both the non-GAAP and the GAAP perspective. The fact that there is something very special here is best illustrated in a wonderful quote from an Seeking Alpha article “Memo To Apple Bears: Give Up For Now”. In this article, Author Bill Maurer states: “One thing I can't stand is what I call two-sided criticism. This occurs when a person (or company in this case) is criticized for doing one thing, but when it does the other, it gets criticized for that as well. A good example is Netflix (NFLX). The Netflix bears criticize the company for its lack of profitability when Netflix spends heavily to expand internationally, which lowers profits. But if Netflix were to focus on profitability and not expand internationally, the company would be criticized for not growing revenues and its subscriber base. You can't have it both ways.” In fact in one very unique example investors can have it both ways: TSLA. Tesla offers simultaneous growth and profits. I am personally appalled that this key message of Tesla’s Q3 was drowned out by ignorance, FUD and media hysteria about a couple of non-injury accidents. In Q1 Tesla has proven beyond all reasonable doubt that it was in command of a disruptive technology (more on that later). There is not one FUD piece on Tesla that has stooped low enough into absurdity to suggest that a non-electric vehicle could compete with Tesla’s technology. There is no electric vehicle in evidence even in the design or prototype stages that threatens to approach Tesla’s lead while in fact Tesla’s technological lead in both vehicles and charging infrastructure continues to accelerate from an established base of both technology and live customer feedback. In addition to its disruptive technology, in Q3 Tesla provided validation of its disruptive business model (more on that later too): The ability to demonstrate rapid cash-flow positive expansion in an industry previously thought to be impenetrable by a newcomer owing to its capital intensive nature. On the actual meaning of disruptive technology: I use the term 'disruptive' as originally coined and defined in the Innovator’s Dilemma. I feel that it is very important to make clear that I am not simply abusing the term 'disruptive' as a buzzword or using the dictionary definition that equates disruptive with nuisance and destruction. The Innovator’s Dilemma was categorically not written as a formula for entrepreneurs seeking to cause disruption. In fact this very tempting misinterpretation is specifically warned against in the text. Personally I believe that a business whose guiding principle is one of destruction is a business that is fatally distracted from adding value to its customers, putting it at a competitive disadvantage to its intended prey. Surviving the threat of tech disruption in a fast-paced world is hard enough for most businesses let alone attempting to play the god-role by reverse-engineering those laws. The Innovator’s Dilemma was written as a survival guide for market-leading businesses in the form of a tool to identify and defend against the emergence of disruptive technology - a virtually unstoppable systematic phenomenon that has destroyed market leaders throughout business history. From the Innovator’s Dilemma - When New Technologies Cause Great Firms to Fail by Clayton M. Cristensen. “Most technological advances in a given industry are sustaining in character. An important finding revealed in this book is that rarely have even the most radically difficult sustaining technologies precipitated the failure of leading firms. Occasionally, however, disruptive technologies emerge: innovations that result in worse product performance, at least in the near-term [In the case of Tesla the cost per unit range of the vehicle is not as attractive as the cheapest second hand ICE vehicle]. Ironically, in each of the instances studied in this book, it was disruptive technology that precipitated the leading firms’ failure. Disruptive technologies bring to a market a very different value proposition than had been available previously.” [The first iPod was expensive and of little use without a computer running iTunes, but it diverted value a freedom from predefined playlists from the record industry to the customer in the same way as a Tesla vehicle diverts value and freedom from predefined filling stations from the oil industry to the customer]. Principle #1: Companies Depend on Customers and Investors for Resources. As a result, companies find it very difficult to invest adequate resources in disruptive technologies—lower-margin opportunities that their customers [or dealers] don’t want—until their customers [or dealers] want them. And by then it is too late. Principle #2: Small Markets Don’t Solve the Growth Needs of Large Companies Many large companies adopt a strategy of waiting until new markets are “large enough to be interesting.” And by then as a result of the considerable advantage accorded to first movers in emerging markets for disruptive technology, it is too late. Principle #3: Markets that Don’t Exist Can’t Be Analyzed In dealing with disruptive technologies leading to new markets, however, market researchers and business planners have consistently dismal records. In fact, based upon the evidence from the disk drive, motorcycle, and microprocessor industries, reviewed in chapter 7, the only thing we may know for sure when we read experts’ forecasts about how large emerging markets will become is that they are wrong. Companies whose investment processes demand quantification of market sizes and financial returns before they can enter a market get paralyzed or make serious mistakes when faced with disruptive technologies. Principle #4: An Organization’s Capabilities Define Its Disabilities Example: Values that cause employees to prioritize projects to develop high-margin products, cannot simultaneously accord priority to low-margin products. The very processes and values that constitute an organization’s capabilities in one context, define its disabilities in another context. [The manufacturer of ICE vehicles is unable to invest heavily in promoting the relative merits of EVs vs the limitations of ICE vehicles without harming its business disproportionately]. Principle #5: Technology Supply May Not Equal Market Demand Disruptive technologies, though they initially can only be used in small markets remote from the mainstream, are disruptive because they subsequently can become fully performance-competitive [or cost competitive] within the mainstream market against established products. This happens because the pace of technological progress in products frequently exceeds the rate of performance improvement that mainstream customers demand or can absorb. [Citing limits for a requirement of top speed range and acceleration]. As a consequence, products whose features and functionality closely match market needs today often follow a trajectory of improvement by which they overshoot mainstream market needs tomorrow. [Tesla Gen III is slated to do just that in the form of a car in family with the Model S at a base price of $35,000 USD and running economies sufficient to reduce household budget equivalence to the purchase of a $20,000 ICE vehicle]. Note the following excerpt (written in 1997): “good” companies often begin their descent into failure by aggressively investing in the products and services that their most profitable customers [car dealers] want. No automotive company is currently threatened by electric cars, and none contemplates a wholesale leap into that arena. The automobile industry is healthy. Gasoline engines have never been more reliable. Never before has such high performance and quality been available at such low prices. Indeed, aside from governmental mandates, there is no reason why we should expect the established car makers to pursue electric vehicles. But the electric car is a disruptive technology and potential future threat. The innovator’s task is to ensure that this innovation—the disruptive technology that doesn’t make sense—is taken seriously within the company without putting at risk the needs of present customers who provide profit and growth. Of key takeaways from the Innovator’s Dilemma the most important to my mind is this: The effect of a confirmed disruptive technology (confirmed = embraced and propelled forwards by evidence of customer adoption in preference to a previous technology) is not a force that is exerted by a tiny company upon many members of a large industry. That concept is bait for valid ridicule. That Tesla should march out with its 20,000 unit sales and cower a 80 million unit production industry into submission by force is to miss the point, deliberately in the case of FUD, or otherwise. Public proof of the emergence of a disruptive technology acts directly on the major players with a force equal and opposite to their own size and weight without any act of aggression required on the part of the small challenger representing the disruptive technology. Tesla does not need to pay any attention to disrupting a market, it can and does focus whole heartedly on its own progress and customers. In the case of Tesla, the technology (and with it the new value proposition of dealership-free, gasoline-cost-free sales, no-fuss silent sports performance, convenient home charging and minimal maintenance) is in and of itself a poisoned pill to the tried and trusted methods of making money with ICE technology. Market leaders have far too much to loose from swallowing that pill in terms of disruption to their existing business and sales model and far too little to gain in terms of measurable ability to access an equivalent mass market for their own electric vehicle designs. It is the internal risk and reward equation that precludes crushing Tesla in direct competition for the electric vehicle space despite all appearances of an overwhelming weight of cash and resources to do so (although it cannot be ignored that Tesla's proven design and engineering resources are not actually inferior to those of Ford, GM and so on, they exceed the capabilities of most governments - see spacex.com). Because of this and not because of Tesla, the major automotive manufacturers are powerless to commit their resources to attacking Tesla’s moat and will very predictably remain powerless until Tesla has proven that the market for electric vehicles is big enough to attract the support of a majority of dealers and investors in legacy automotive companies to go after the electric vehicle market in earnest. By then Tesla’s first mover advantage comprising brand-leadership, technical leadership and supply chain dominance in the technology of preference will be virtually unassailable. Additionally at that point the old majors will be have suffered a creeping loss of market share and brand value (and management credibility) resulting from a clear trend of customer migration to the new technology that may indeed have crushed relatively thin operating margins making massive reinvestment in R&D and tooling for electric vehicle technology all the more difficult. In my opinion, the auto industry at large is already far too late to halt or even to deflect the deterministic outcome of this formula. A smoke and mirrors foray into hybrids and FCVs will not cut it. A note on this non-technological moat enjoyed by Tesla from the book: “Despite their endowments in technology, brand names, manufacturing prowess, management experience, distribution muscle, and just plain cash, successful companies populated by good managers have a genuinely hard time doing what does not fit their model for how to make money. Because disruptive technologies rarely make sense during the years when investing in them is most important, conventional managerial wisdom at established firms constitutes an entry and mobility barrier that entrepreneurs and [TSLA] investors can bank on. It is powerful and pervasive.” Disruptive technology as defined in the Innovator’s Dilemma is not exclusively technological. It is further proof of a disruptive technology (in the technological sense) that Tesla has in fact created a new value network in terms of direct internet-enabled sales and a value proposition that crosses the boundaries between automotive manufacturing and fuel supply. With the advent of the Model S, a household budget for both car and gasoline can now be consolidated into the purchase of an objectively better car in the driveway than an equivalently priced gasoline car, forsaking a lot of gasoline that is inherently worthless to the owner of an electric vehicle. However I would argue that Tesla’s business model is not just symptomatic of disruptive nature of the technology. There are two separate disruptive “technologies” in evidence, and only one of them is technological, namely the car and Supercharger network. The other “technology” as defined in the Innovator’s Dilemma is the cash-flow positive sales model and this appears to fit the definition also. Arguably, even were the Tesla product offering be simply another ICE vehicle with great looks, super aerodynamics, extreme performance, superior internal space and seating capacity, market-leading safety, best in class environmental credentials, engineering affiliated with a rocket company and so on it would be a new and disruptive technology entrant in the auto industry purely based upon its direct to consumer cash-flow positive sales model. The benefit of Tesla’s business model, to both Tesla (and its investors) is an un-ending supply of working capital for 100% compound annual hyper-growth alongside simultaneous profits without any need for debt or dilution. This was proven with the addition of $49 Million to the bank balance in Q3 2013 during rapid expansion in Europe and Asia and simultaneously investment in R&D for the Model X and regional variants of the Model S. The Tesla business model thoroughly dismisses the received wisdom that it is next to impossible for an new entrant to gain traction in the auto industry owing it its capital intensive nature. Not only has the Tesla business model smashed down the traditional barrier to entry into the auto industry, it supports a sustainable growth trajectory that is orders of magnitude greater than any incumbent is capable of achieving. Nothing like this has been witnessed since the dawn of the auto industry and barely if ever before has it been witnessed in the whole history of the economics of manufacturing. It’s an astonishing business model, but why is this a disruptive “technology”? Again by looking at the intractable difficulties faced by incumbents should they consider simply adopting Tesla’s technology to compete on a level playing field. Ford for example would radically increase the efficiency of its capital and free up $billions for R&D, acquisitions and sales-growth by adopting the “technology” represented by Tesla’s business model, but it is internally constrained from doing so. Even if it were legally feasible, which it isn’t, Ford would first need to dismiss or to purchase its dealer network and with it the security of a proven and calculable source of its whole income stream from the sale of vehicles. Ford would then need to insist that from then on, its customers must reserve Ford vehicles and pay cash on delivery (or arrange credit up front with Ford as beneficiary) thereby enabling Ford to operate purely on the credit terms available from its suppliers and free itself from sinking any of its own capital in the production of finished vehicles. Ford simply does not have the product differentiation in a crowded and oversupplied ICE market to make that possible. The attempt to insist on cash flow positive customer reservations would result in Ford’s competitors advertising the convenience of cars with virtually identical features and benefits available to buy without waiting. For this reason and with no act of aggression required on the part of the small challenger, simply based upon the existence of the “technology”, neither Ford, GM, Chrysler, Toyota, BMW or any other currently leading auto manufacturer can afford to adopt or to compete on an equal footing with Tesla’s cash-flow positive business model. In the nature of disruptive technologies, the approach is only available to new entrants (or new business units spun off from the majors). Neither of which has happened during the ten year lead (and counting) accumulated by Tesla to date. The laws governing the disruptive technology cycle point to a Tesla that grows much faster than the remainder of the industry until leadership positions naturally intersect and ultimately reverse. It does no harm to Tesla's progress that this mathematically predictable outcome is hard to believe or imagine. As a second to last word, on the subject of the Innovator’s Dilemma, the overt purpose of that work was as a stark warning to well-managed market-leading companies to take disruptive technologies seriously, and to do so before the mechanisms of disruption set in hard. While an inherently churlish argument to say ‘your disbelief is my proof’ it is true to say that the mechanisms of disruption are known to be in force when they are clearly in evidence and simultaneously met with denial and disbelief. Perhaps this is the real relevance of the excessive FUD Tesla has been exposed to. The truth of it is seen in the inverse: The only credible threat to the emergence of Tesla as a market leader of a future auto industry dominated by electric vehicles would have been clear evidence that the incumbent auto industry at large had declared with one voice “holy crap these guys are going to eat our lunch unless we divert resources to leadership of this new reality”. That cry would have needed to go up by around 2008 at the latest to curtail Tesla’s first mover advantage and the natural forces of the tech disruption cycle progressing towards their natural conclusion. It did not. As at December 2013 Tesla finds itself in a clear blue ocean of absolutely predictable, absolutely uninhibited cash flow positive expansion verses an industry in denial. One more thing. The Innovator’s Dilemma contains an analysis of the repeated rise and fall of companies in the hard disk market. As an aside to the topic of functionality oversupply in the PC market, this 1997 text mused on the opportunity for “applets” running on “internet appliances” disrupting the market for PCs (Microsoft being at its zenith at the time of writing). For anyone reading this on an iPhone or iPad, here is a very good reason why this was Steve Jobs favorite business text. T The following is Tesla’s internal production targets from a presentation given by JB Straubel at Stanford September 2013 (). The method to achieve these figures, including the ability to raise sufficient capital from internally generated cash for all that is required, is indicated above. Thank you once again for the time taken to read this lengthy piece. I hope it has addressed a number of misplaced concerns that have been overdone in the media of late and has consequently been of value to you. Julian Cox.