Did Tesla Motors Hit a Wall?

Did Tesla Motors (Nasdaq: TSLA  ) just hit a wall?

The Silicon Valley electric-auto maker's stock was near $35 just a few days ago, but it fell sharply Thursday after a Morgan Stanley analyst downgraded the stock and cut his price target by 37%, saying in a research note that electric vehicles are "not ready for prime time" and that expected market share gains were unlikely to materialize.

Tesla stock is trading right around $30 as I write this on Monday. Is that a buying opportunity? Or is the analyst right that Tesla's road is looking rocky?

There's prime time, and there's prime time
Full disclosure: I'm not an ardent Tesla fan. While I've admired the company's first car, the Roadster, I have been seriously skeptical of the idea that any start-up can enter the automotive mass market and thrive. Building cars to modern global standards of quality, reliability, and safety while making a profit is hard. The companies that are doing it most successfully -- Ford (NYSE: F  ) , Toyota (NYSE: TM  ) , General Motors (NYSE: GM  ) , Honda (NYSE: HMC  ) , Volkswagen -- are global giants with extensive engineering and research resources, decades of institutional experience, and vast economies of scale.

And even with those vast efficiencies and economies of scale, these companies are getting by with margins in the 5%-8% range. If ever there were an industry with an enormous moat, automaking is it. Just ask the Chinese automakers that are finding themselves unable to compete with the global giants in their home market (where the rules favor them).

Tesla's most ardent proponents often argue that the company has no competitors, that its upcoming Model S is a unique and compelling proposition that the mass market will find hard to resist. But plain and simple, it's not: Outside of the small universe of well-heeled gadget geeks and early adopters, it's an expensive luxury car powered by a technology that many buyers will have qualms about. Overcoming the technological qualms is one thing -- and Tesla may well have success there -- but the Model S and the Teslas that follow still have to compete well with the alternatives in the marketplace.

Put another way, the Model S's interior, on-road experience, fit and finish, and safety have to be on par with the BMW or Audi or Lexus that the prospective buyers in that financial weight class are driving today -- if Tesla is going to expand its sales reach beyond its gadget-geek base into the mass market.

That's an extremely high bar -- perhaps the highest in the global auto business. And that, in a nutshell, is why I have been a Tesla skeptic, though I've become more optimistic as Tesla has developed working relationships with several of the leading big-league automakers. But Morgan Stanley's downgrade was based on something a bit different, a big-picture issue, but I think its effect on Tesla is unlikely to be dramatic.

Remember that rush to electric cars? It's not happening... exactly.
Skepticism aside, Morgan Stanley and I agree that Tesla appears to be doing a great job of executing on its business plan. Development of the Model S is on schedule, the company has signed major agreements to supply technology and components to automakers like Toyota and Mercedes-Benz maker Daimler, and the company's marketers have so far done good work laying the groundwork for the Model S's scheduled launch in mid-2012.

But Morgan Stanley's Adam Jonas didn't really downgrade Tesla as much as he downgraded electric cars. Jonas had previously predicted that EVs would make up 8.6% of the global car market by 2025, but lowered that estimate to 4.5% last week. Certainly prospects for EVs look a bit more glum now than they did a year or two ago: Technological teething troubles like the Chevy Volt's battery issue won't help speed adoption, and high prices, lack of recharging infrastructure, and range concerns continue to push buyers in other directions.

Toyota chief engineer Satoshi Ogiso recently made it clear that the company is hedging its electric-vehicle bets in a big way, pushing development of fuel cells and other alternative technologies alongside EV work, because -- in Toyota's view -- it's not yet clear which of these technologies will pan out. Meanwhile, the company (rightly, I think) expects hybrids -- not electrics -- to be the dominant vehicles in developed markets in a decade.

But what does that mean for Tesla? From a simple analytical point of view it's easy to say that electric cars will account for X% of sales and Tesla could capture Y% of that, so if X falls then Tesla's sales must fall as well. That seems to be where Jonas is coming from, but I think that's an imperfect equation. If Tesla's cars are good and fairly priced, they'll sell -- whether or not other automakers decide to push on with EV development instead of focusing on hybrids or other technologies, and even if a smaller proportion of consumers decide to make the leap to an electric car. In other words, the pie may shrink, but if Tesla's products pan out, the company seems well-positioned to capture a bigger piece of it.

Now, if EVs are such a flop that no significant infrastructure to support them emerges, that will hurt Tesla's chances. But at least in the major developed nations, that infrastructure is likely to happen anyway; government pressure is already putting things in motion. I think this is unlikely to be a factor.

Long story short, I agree that EVs are unlikely to be adopted as widely and quickly as optimists were projecting a year or two ago, but I don't agree that that necessarily means that Tesla's chances of success are diminished. Tesla's fate, for better or worse, still appears to be in its own hands.

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