Why Advertising Spends Won't Really Hurt Tesla Stock

  •  Tesla is due to unveil its first mass-market EV, Model 3, in March 2016.
  • Tesla has traditionally spent minimally on ads but Wall Street is now worried the company might have to jack up its ad spend.
  • How likely is this and how will it impact on Tesla's already thin margins?

During its 13-year lifetime, Tesla (NASDAQ:TSLA) has managed to sell its EVs by relying almost exclusively on referral programs, the cult personality of its brand, and strong buzz. In sharp contrast, traditional automakers such as General Motors (NYSE:GM), Ford Motor (NYSE:F), Fiat Chrysler (NYSE:FCAU), and Toyota Motor Corp (NYSE:TM) rank among the 10 heaviest advertising spenders in the U.S., with each spending billions of dollars each year on ads.

Now Wall Street fears that Tesla might not continue having it so easy for much longer. With Tesla due to launch its first mass-market vehicle, the Model 3, in March this year and production slated to commence in late 2017, Wall Street fears that it’s not realistic to expect Tesla to continue relying on buzz power alone.

Meanwhile, investment firms have been making estimates all over the map trying to project Tesla’s advertising costs 3-5 years out. Will Tesla go light on ad spend or go flat out like traditional automakers?

Robert W. Baird analyst Ben Kallo says:

"As they get into making millions of cars, they will have to start trying to reach a broader audience, whether that means television commercials or some other media,"

Tesla CEO Elon Musk refused to tip his hand when recently asked an open question during Tesla's Q4 earnings call regarding exactly how Tesla hopes to connect with the $35k-mid-range Model 3 buyer.

Tesla Might Not Have To Spend Heavily On Ads Till 2020

The chief reasons why Tesla has been able to spend minimally on ads yet continue growing its sales at an admirable clip are: much less competition in the pure EV space and Tesla’s powerful brand. Out of the 30 EV brands available in the U.S., only 12 are pure EVs, the category where Tesla’s EVs belong, while the rest are plug-in hybrids. Tesla is currently the largest and most popular EV manufacturer in the U.S. and maybe even globally, with more 30% of the U.S. EV market. Tesla is so confident of its leadership in the EV space that the company has opened up its patents to potential competitors and even recently started selling power trains and battery packs to rival EV manufacturers.

To underscore the strength of Tesla’s brand, consider that Tesla sold as many EVs globally in 2015 as the next three competitors (all traditional auto makers), and managed to grow sales by 40% in a down year for EVs when everybody else recorded double-digit declines primarily due to low oil prices.

In sharp contrast, there are more than 40 traditional auto manufacturers in the U.S., not counting imported brands. The U.S. auto market is highly fragmented and not a single player, including giant GM, has more than 20% market share.

Tesla likely won’t have to increase its ad spend significantly until it achieves its first target of half a million EVs by 2019-2021, due to the power of its brand. The company might have to significantly grow its ad spend thereafter as competition stiffens. But even then, the effect on Tesla’s margins probably won’t be significant enough to cause much trouble for the company since Tesla has projected that it will achieve full profitability once it hits the half a million unit sales mark.

Traditional Auto Makers Ad Spends

Just how much do traditional auto makers spend on ads? Turns out, quite a lot.

For instance, GM spent $3.1B on ads in 2014, the third highest ad spend by an American company during the year. GM sold 9.9M vehicles in 2014, which implies that it spent $313 on ads for each vehicle sold.

Ford Motors spent $2.5B on ads during the period, the 6th highest by an American company, and sold 6.3M vehicles. This implies the company spent $397 on ads for each vehicle sold.

Fiat Chrysler spent $2.2 B on ads in 2014, the 8th highest by an American company and sold 4.75M vehicles, which works out to $463 spent on ads for each vehicle sold.

All that averages to about $370 spent on ads by the three companies for every vehicle sold. Let’s assume Tesla sells 500k EVs by 2020 and 80% of those are Model 3 with the rest being Model S and Model X in equal proportion. This implies that Tesla’s ASP will be 43k if current Model S, Model X, and projected Model 3 prices hold. If Tesla spends roughly the same on ads as the three heaviest traditional auto makers, then it will translate to less than 1% of revenue, not enough to cause anyone sleepless nights.

Investor Takeaway

Tesla might not have to significantly jack up its ad spends as it accelerates to its goal of becoming a mass producer of EVs primarily due to the power of its brand. The company might have to ramp its advertising spend some time in the future, but even then, it probably won’t be big enough to affect its margins by much.

Brian Wu Brian Wu   on Amigobulls :
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