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An Untapped Market That Tesla Could Dominate

Thursday - 5/23/2013, 3:55pm  ET

Tesla has been an absolute gorilla on the markets recently. The company just completed a new financing round, giving it a crisp $1 billion to work with. That is allowing Tesla to pay off a $450 million loan it was given by the federal government to build its advanced vehicles.

The cash raised in this round will also be used to help develop new models. One example is the Model X, a sport-utility vehicle that could offer Tesla enormous margins when it can get such a vehicle to market at scale. 

Leveraging Tech

Tesla is in a great position. It is redefining what we think about automakers. Instead of simply manufacturing cars, Tesla is a technology company, bringing fresh ideas into what was previously a stagnant auto industry. From thinking about self-driving vehicles to building service stations and offering customers unique financing, it's clear why investors are clamoring for Tesla stock.

Yet there is a market that has been serving the traditional automakers well that Tesla could dominate.  The company wants to shake up the market for passenger cars. And with Tesla's knowledge in advanced automotive technology, it have an opportunity to further entrench itself.

Consider the first-time car buyer.  Since young people often find their career-defining jobs in the city, they need a vehicle that reflects their urban environs. These potential car owners are looking for something that looks good, is efficient and can be navigate the city.

What kind of car are we talking about? We're talking about small cars, a category that Tesla has not touched. At least it hasn't yet. 

The Competition

The big automakers are already deeply ingrained in the small-car market. General Motors (NYSE: GM) knows that in order to captivate new customers, it has to get small cars right. GM has learned that getting smart about the small-car market can pay huge rewards. Brand loyalty is important to consumers.

That is how rival imports were able to steal market share from GM and Ford Motor Company  in years past. They made high-quality small cars. When consumers were ready to trade in and perhaps upgrade, they stuck with their Toyota or Honda brand. 

Competing with the big automakers in small-car frames will pose its share of difficulties for Tesla. For example, Ford currently has three small cars in its lineup: the crossover Escape, the hatchback Fiesta and the Focus sedan. 

Tesla Versus Scale 

Tesla will be challenged in terms of Ford's sheer scale. But that does have some advantages. In order for Ford to make a profit on small cars, it must deliver them by the tens of thousands. Ford also relies on a complex network that spans around the globe for car parts as well as dealers that sell their models.

Tesla is operating on a much smaller model, and has the advantage of being more nimble and perhaps receptive to customer feedback. That feedback is going to be important for Tesla. Its current lineup includes the Model S sedan and the Model X sports car. Those two vehicles reside in the premium market for vehicles since they start at over $60,000.

Making a small car for Tesla that could start in the $30,000 range would probably be ideal. Tesla CEO Elon Musk has stood by the fact that Tesla cars have incredible resale value, and to be able to do the same in the compact class of cars would be a great selling point for consumers. 

A Battle Could Ensue

Ford and GM aren't going to sit around and let Tesla take a share of their small-car market. They are going to put up a fight. Ford is releasing the C-MAX this year, a hybrid model that appears to be taking on the Toyota Prius. GM has the electric Volt, but has been struggling to sell it in volumes. GM needs to lower the Volt's $38,000 price point in order to make it viable to potential customers who are probably the type that buy small cars. 

Bottom line: Don't count the incumbents out. GM offers good value now that the company has been restructured. It is even rejoining the S&P 500, a testament to its rebound from 2009. Ford offers good value as well, but it seems to be overly focused on trucks in the United States, which could be considered a concern given that the market for trucks is a high-margin yet dwindling-volume business. 

As you can see from the chart above, auto sales are rebounding from the recession. Now is a great time to invest in automakers, and Tesla is a great stock to be in for the long haul. Tesla CEO Elon Musk just purchased $45 million more in Tesla stock himself. That's a sign that smart investors should move money into a company with an enormous ceiling. 

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