What Would a Tesla-BMW Deal Look Like?

NEW YORK (TheStreet) -- Fair disclosure right up front: The thesis presented in this article is speculation. I don't know anything, I could be completely wrong, but my conclusion is based on the logic of the argument presented.

With that out of the way, the purpose of this article is to advance the thesis that I believe the meeting BMW had with Tesla (TSLA) on June 11 -- as reported by none other than Elon Musk on June 12 -- will actually lead to a deal, and probably relatively soon.

First, let's deal with the core of any deal: Motivation. Why would BMW want to enter into a supercharging deal with Tesla and vice versa?

First, BMW: Automakers are generally uncomfortable dealing with fueling infrastructure. Many of these reasons are legal. For example, can you imagine General Motors' (GM) lawyers signing off on a project that would place hundreds or thousands of unmanned 440-volt DC chargers along the world's freeway rest stops? What if someone electrocutes himself?

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In other words, car companies are leery about the liability of managing unmanned electric truck stops. But there is another reason. Automakers and oil companies have a long history of being under attack by government for vertical integration. For example, existing automakers are famously disallowed from selling cars directly to the consumer.

One could also go back to the 1909 U.S. government antitrust case against Standard Oil. Old automakers don't want to become accused of vertically integrating the transportation and fueling food chain, and they don't want to spend anymore time in Congressional hearings defending their actions, on top of the painful experiences with bailouts and recalls.

Tesla, on the other hand, has no such institutional memory or inhibitions. Elon Musk famously tweets in a manner that would cause a general counsel to have a heart attack. Musk thinks big and wants to build a factory that vertically integrates as far as possible backward in the transportation food chain, seemingly all the way down to the lithium mine. In the other direction, he would integrate forward all the way to selling spacecraft services for travel to Mars.

For Musk, vertical integration is not taboo. It is the opposite. It is religion.

Any automaker, let alone a foreign one such as BMW, would be extremely leery about engaging in a construction program along America's freeways, installing "BMW fueling stations for electric cars" in plain sight of every potential adversary. That's why when Tesla offers to do this for them it is like throwing the old automaker a lifeline.

So the case for an automaker such as BMW to take a supercharger deal with Tesla is pretty easy to make. The difficult one to explain is why Tesla would have any interest in entering into such a deal.

First, let's talk about money. It's obvious that a company such as BMW would have to pay Tesla for this. It could be structured in any of numerous ways, but it doesn't really matter in terms of Tesla's motivation. Tesla is not lacking for money. BMW might pay Tesla some sort of construction contribution, as well as usage fees when BMW cars utilize the network -- all very straightforward.

Basically, BMW would outsource this infrastructure project to Tesla. Outsourcing is good, especially for BMW in this case. It's like paying a maid or handyman instead of doing the work yourself.

So if it's not that much about money, what's Tesla's primary motivation?

Some will argue Musk is doing this out of the goodness of his shareholders' hearts, that he wants to change the world. There is probably some truth to that theory, but I don't think this means he will just roll over in a negotiation. Not at all. He wants something important from BMW. What is it?

Tesla is very proud -- and rightfully so -- of its charging connector. Everyone would agree that it is more elegant than the competitive solutions. There is no way Tesla is going to change it. If Tesla can get the rest of the industry to somehow bend in its direction on the charging connector -- even if supplying existing BMWs with an adapter -- it would mean a huge principled win for Tesla.

There are a variety of technical issues surrounding making non-Tesla cars work with Tesla's superchargers, many of which are well above my non-engineering pay grade. I have asked more knowledgeable people to speculate in terms of how this could be done, and there is simply no consensus on that subject.

In any case, here are some of the issues:

1. Handling the electricity: How can the infrastructure and the car be modified so as to ensure that it works at all, even at a reduced charging rate? A solution may have both hardware and software components.

2. Billing: The current Tesla superchargers are designed for Tesla cars only and don't have credit card swipes or equivalent. This makes them cheaper to make but it's harder to make them work with non-Tesla cars. Again, this would involve hardware and software development.

The critical thing becomes this: What part of a deal could even be made to work on cars not specifically engineered to handle Tesla's superchargers, requiring only software upgrades and an adapter? If BMW or other automakers need to redesign their cars with new electronics, new software and perhaps even new batteries, we are talking at least three to five years for this to physically work.

I am not saying that it is extremely likely, but if the Tesla-BMW deal involves not just charging but also a battery deal then this is indeed an even much bigger deal overall. I think the only reason BMW would consider such a deal is if it were technologically necessary to be part of the supercharging network. That becomes a much taller hurdle.

Given the long engineering and testing cycles of the automotive industry, and battery-electric vehicles (BEVs) in particular, a Tesla-BMW battery deal would not likely be implemented in a BMW car until 2019. In the meantime, in a worst-case scenario, nothing would work at all, or only at a reduced charging speed (say, 60 miles per 30 minutes, or one-third of Tesla's rate).

There is a far broader strategic rationale for Tesla to open up its charging network to BMW (and everyone else for that matter). By opening up the network while it still has an infinite lead in long-distance supercharging, Tesla, in effect, reduces the probability that someone else will invest the money to compete in that area. It clears the competitive field until the other automakers have re-engineered next-gen products (for 2019) that could take advantage of Tesla's superchargers.

Basically, what happens is Tesla becomes an indispensable part of the infrastructure for BMW and presumably shortly thereafter also the other automakers. This is in contrast to the far more perilous business of actually making cars.

When you make cars, you are in a risky business. It takes only one product mistake, one recall, one change in automotive fashion -- and you're out. You need to be large and diversified in order to tough it out over the long run. Musk probably doesn't feel comfortable having this kind of patience. One more car -- the Model 3 -- and he's off to Mars. Bye, bye.

At least if you're in the supercharger business you're guaranteed some profits. Gasoline stations may work on razor-thin margins, but at least you're guaranteed a percent or two in profits. If you owned all the gasoline stations, you would make a good living.

And herein lies the rub in this type of deal for Tesla: Longer-term, Tesla will feel the impact of having surrendered its primary competitive moat -- supercharger exclusivity -- in exchange for something not as valuable. This means two things for Tesla in the longer term:

1. Tesla's competitors can now plan for 2020 and beyond, knowing that all they need to do is to make electric cars with long range, and then they can use their scale advantage to accomplish better margins and better pricing.

2. Whether Tesla exits the actual car-building business or not, it will be stuck collecting low-margin profits from an electric car charging network, plus perhaps a battery-pack building business. Those are low-multiple businesses. $100 million in annual profits might support a $1 billion market cap; $1 billion in annual profits might support a $10 billion market cap.

I believe Tesla wants to announce a supercharger deal with BMW before it reports earnings in August. Tesla's current revenue and bottom-line numbers are not supportive of a $30 billion fully diluted valuation, so it would be beneficial for Tesla to deflect the market's attention in favor of landing BMW as its first supercharger partner -- and perhaps more.

This is only one scenario. There are other scenarios. Perhaps BMW could not stand Tesla's terms and is proceeding along a different route. Perhaps BMW will partner with some other entity that will help it build their versions of superchargers. That is also a possibility.

Either way, I expect this to be sorted out very soon. Stay tuned. Sparks are about to fly.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates TESLA MOTORS INC as a Hold with a ratings score of C-. TheStreet Ratings Team has this to say about their recommendation:

"We rate TESLA MOTORS INC (TSLA) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its solid stock price performance, revenue growth and notable return on equity. However, as a counter to these strengths, we also find weaknesses including unimpressive growth in net income, weak operating cash flow and poor profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • This stock has managed to rise its share value by 79.48% over the past twelve months. Regarding the stock's future course, our hold rating indicates that we do not recommend additional investment in this stock despite its gains in the past year.
  • TSLA's revenue growth trails the industry average of 21.9%. Since the same quarter one year prior, revenues rose by 10.4%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • TESLA MOTORS INC's earnings have gone downhill when comparing its most recently reported quarter with the same quarter a year earlier. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, TESLA MOTORS INC continued to lose money by earning -$0.71 versus -$3.70 in the prior year. This year, the market expects an improvement in earnings ($1.21 versus -$0.71).
  • Net operating cash flow has declined marginally to $60.64 million or 5.36% when compared to the same quarter last year. In addition, when comparing the cash generation rate to the industry average, the firm's growth is significantly lower.
  • The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Automobiles industry. The net income has significantly decreased by 542.7% when compared to the same quarter one year ago, falling from $11.25 million to -$49.80 million.

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