Tesla Motors Inc (NASDAQ:TSLA) revealed some big news Tuesday. The company is acquiring a German firm, Grohmann Engineering, which focuses on automating industrial processes. With Tesla preparing to ramp up manufacturing capacity to a large degree by 2018, it makes for a timely purchase.
The Tesla stock price was up slightly in Tuesday trading as the market reacted to the deal, along with broader election-related factors.
Not A Big Cash Outlay
Tesla chose not to disclose the purchase price for Grohmann. And Tesla skeptics quickly raised the alarm, suggested that Tesla may have to issue equity or otherwise raise cash to pay for Grohmann.
I think that’s a mistake, but I don’t see immediate risk to Tesla stock from this deal. While we don’t know all that much about Grohmann, we do know that the company employs fewer than 1,000 people. And in 2014, the company generated a relatively small 95 million Euros ($105 million) in revenues.
Even if Tesla paid 3x sales, which seems a little on the high side, we’re still talking about a deal coming in around $300 million. This is no second coming of the SolarCity Corp (NASDAQ:SCTY) deal; Grohmann won’t break the bank. This is a bolt-on sort of purchase, not a massive move.
Tesla said in a corporate blog post that it intends to create 1,000 engineering jobs in Germany in coming years, suggesting that the acquisition is the base of a new initiative, rather than something that immediately resolves an existing problem.
Is Tesla Ready For Model 3 Production?
The bigger story is not this deal in itself, but what it says about Tesla’s capabilities. The company is less than a year away from going into full-throttle production of its mass market vehicle. At this stage, it is most interesting that Tesla would be adjusting their manufacturing system.
Bears will surely point to this deal as indicating that Tesla isn’t ready for the primetime. Tesla is, of course, trying to ramp from around 80,000 vehicles per year to 500,000 per year within two years. 2017 guidance is hard to pin down, but seems to be somewhere near the middle of those two figures.
It’s important to remember that Tesla relies on one factory that has no history of being able to produce anywhere near this sort of quantity of cars. Elon Musk always shoots for the stars; the Model 3 rollout is a huge undertaking. TSLA will attempt to leap from successful niche manufacturing to the mainstream. The rewards for success would be great, but it is fraught with risk for Tesla stock.
Solving TSLA Stock’s Per-Unit Cost
While it’s easy to see negatives attached to this deal, there’s real strategic rationale, and it could end up boosting the Tesla stock price. The company operates out of a high-cost manufacturing facility.
Tesla could accept these costs when selling luxury vehicles. However, mass production of cheaper automobiles requires a different operating mindset. The competition now comes from cheap Asian and Mexican-made vehicles, rather than other high-end producers.
One option for Tesla would be to build manufacturing in areas with cheaper labor. Even within the U.S., California is a particularly poor choice for a company that wants to optimize its cost structure. However, it appears that, at least for now, Tesla isn’t interested in operating a more diversified network of manufacturing facilities.
With that in mind, the next best solution is to make your high-cost labor far more efficient. Automation solves the high-cost problem by allowing the facility to operate with far fewer employees.
Tesla: Better Factories?
In fact, a reading of the company’s blog post suggests that Tesla has a grand vision for this acquisition. You can see that in the following bit:
As the machine that builds the machine, our factories are so important that we believe they will ultimately deserve an order of magnitude more attention in engineering than what they produce. At very high production volumes, the factory becomes more of a product than the product itself.
Tesla believes that its engineering and design capabilities will allow its factories to become the “most advanced in the world.” TSLA stock expects to see “exponential improvements” in production speed and quality of output. This can be achieved, the company believes, while substantially reducing costs.
However, there’s a difference between vision and execution. Other automotive companies have spent decades investing in design and engineering to make their factories more efficient. It feels presumptuous of Tesla to assume that they will be able to build better factories right from the get-go.
TSLA hasn’t yet convincingly demonstrated that it is able to achieve scale with manufacturing at even one factory. So bragging about the world’s best factories might not yet be appropriate.
For comparison’s sake, consider Toyota Motor Corp (ADR) (NYSE:TM). Toyota’s Camry sells more than 400,000 units per year in the U.S. alone. With just one brand and in just one country, Toyota sells nearly as many vehicles as Tesla intends to produce in 2018. And TM stock has far more experience and a much deeper pool of resources with which to optimize its production capabilities.
Anything Tesla decides to do can probably be copied by the bigger players if it is worth doing in the first place.
The Grohmann purchase probably benefits Tesla stock to some incremental degree. At minimum, it’s not a large enough deal to have a big negative impact for Tesla stock in the way SolarCity did. However I’m far from sold on the idea that TSLA will be able to accomplish a quantum leap forward. Automation is a good place to focus, and success in this area would help the company overcome its high manufacturing cost base.
However, Grohmann alone isn’t going to solve Tesla’s manufacturing puzzle. And the company’s claims regarding the world’s most advanced factories seem slightly preposterous.
At the time of this writing, Ian Bezek has no positions in any stocks mentioned. You can reach him on Twitter at @irbezek.
