Tesla Motors Inc (TSLA) 2018: The High-End

However, such an “affordable” car would be much less profitable than the Model S or Model X. While Musk thinks Tesla could potentially rival Porsche with gross margins of 50% or so, that would only be possible if Tesla can maintain its Porsche-like average selling price of roughly $100,000.

A $35,000 car is more likely to have a 15% gross margin. Tesla cannot afford to compromise on quality, so it must start at a quality baseline consistent with other cars in that price range, such as BMW’s 3-Series, Daimler’s Mercedes C-Class, or General Motors Company (NYSE:GM)‘ Cadillac ATS. The additional cost of batteries and an electric powertrain (compared to a standard internal combustion engine) add additional costs for Tesla. Moreover, if Tesla grows as expected, its vehicles will no longer be eligible for the $7,500 federal tax credit in the U.S., which begins to phase out after a manufacturer produces 200,000 plug-in or all-electric vehicles.

Pulling it together
If Tesla can really sell 400,000 “affordable” cars in 2018 for $35,000 while at a 15% gross margin, this would translate to just over $2 billion in gross profit. By contrast, Tesla Motors Inc (NASDAQ:TSLA)’s operating expenses are currently at a $450 million annual run-rate. However, with Tesla going from one product today to three to four products in 2018 and growing sales more than 20-fold, operating expenses could easily soar to $2 billion or even more by then.

In other words, while a cheaper car will dramatically boost volumes, and could contribute $2 billion to gross profit, much or all of that revenue will be offset by corresponding increases in operating expenses. To produce billions of dollars of free cash flow — which is essentially what Tesla’s valuation implies it will do — Tesla will really need to boost gross profit from its high-end vehicles to Porsche-like levels.

Is that possible? Perhaps. It’s plausible enough that I won’t risk shorting Tesla at this point. But it doesn’t make Tesla a buy, either. Everything has to go right just for investors to earn a market rate of return.

The article Where Is Tesla’s Long-Term Upside? originally appeared on Fool.com and is written by Adam Levine-Weinberg.

Fool contributor Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends General Motors and Tesla Motors. The Motley Fool owns shares of Tesla Motors.

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