Morgan Stanley's Starry-Eyed Tesla Upgrade vs. the Facts

Tesla Motors (TSLA) may well be a sensible long-term investment. But yesterday the stock market treated it like an overnight sensation -- thanks to a starry-eyed upgrade issued by one of the i-banks that underwrote Tesla's IPO.

After an extremely favorable upgrade from Morgan Stanley (MS) -- one that called Tesla "America's fourth automaker" -- the shares soared 21 percent before closing Thursday at a nice 17 percent jump to $27.75. (It fell back another 3.9% today.) If investors listen to Morgan, though, the sky's the limit: Analyst Adam Jones rates the stock as "overweight" with a price target of a whopping $70.

Ladies and gentlemen, the auto industry may have its first Henry Blodget.
Speculators might have paused to note that Morgan Stanley isn't exactly a disinterested party -- along with J.P. Morgan, Deutsche Bank and Goldman Sachs, it was an underwriter of Tesla's IPO last year. That may explain the starry-eyed appraisal of the company's prospects. According to Jones, the company could have $9.5 billion in sales by 2020, with more than $1.2 billion annual profits. That assumes the successful launch of affordable electric cars that Tesla has barely thought about yet.

Warts and all: Promise, but no slam dunk
A warts-and-all look at Tesla would see it as a company with decent long-term prospects, particularly from the Model S sedan due next year. But right now it's a lean operation with one slow-selling model (1,500 Roadsters have been sold) whose ground-up electric car is soaking up cash and making big profit announcements unlikely anytime soon.

But Morgan Stanley's analysis appears to be describing a plugged-in company going it alone against clueless competitors who just don't get the electric thing. According to Jones:

The confluence of structural industry change, disruptive technology, changing consumer tastes and heightened national security creates an opportunity for significant new entrants in the global auto industry. California dreaming? We don't think so. In our view, the conditions are ripe for a shake-up of a complacent, century old industry heavily invested in the status quo of internal combustion. The risks are high. So is the opportunity. Enter Tesla.

It's the batteries
Reducing battery costs is key to EV profitability, but I don't know any close observer of the battery business that expects those costs to fall nearly as quickly as they do on Morgan Stanley's chart (right), which is based on Department of Energy hopes.

Another Morgan Stanley chart (below) projects Tesla volumes at an incredible 500,000 by 2025, with most of that coming from the approximately $30,000 Gen 3 smaller car that Tesla has told me repeatedly is on the back burner until the Model S comes out.

The WSJ said that President Obama's energy speech was also a factor in the Tesla stock surge, because he said he'd direct all federal agencies to buy electric cars by 2015. But such Presidential orders seldom see quick results, and any agency that bought $109,000 Tesla Roadsters would quickly be pilloried in Congress.

Morgan Stanley claims that the EV market, buoyed by high gas prices, is underestimated. "We are convinced electric cars will comprise a significant minority of global light vehicle sales medium-term and the majority longer term," the company said. I agree with that, but expect "significant majority" status to last for a long time -- decades -- and the "majority" to come way out on the timeline, 2030 would be an optimistic date. Today there are few models on the market, they're pretty expensive, and most of them are yet in very short supply.

Even the claim that EVs will be a significant minority in the medium term appears to be undercut by the analyst's estimate that electrics and plug-in hybrids will be only 5.5 percent of the global market by 2020. In fact, electric cars are a long-term profit center, and it's very hard to pin down when they'll dominate the market. Few executives I've interviewed want to go on the record with a date, given the uncertainty of battery costs and up and down oil prices.

The conditions for disrupting the auto industry as we know it are there, but they're not "ripe," as Tesla's underwriter puts it. Instead, they might reward patient investors who are willing to wait for the industry to evolve. Tesla would be the first to tell you this. "From the time we went public, we've always said that Tesla is a long-term investment," said spokesman Ricardo Reyes.

Related:

• Tesla's Stock Soars After IPO