You can’t argue with the numbers, can you? Tesla shares are up almost 60% since the beginning of the year, hitting all-time highs in the near-$US350 range, and CEO Elon Musk’s electric carmaker has returned 1,670% since the 2010 IPO.
The market cap, at more than $US50 billion, is bigger than that of General Motors, Ford, and Fiat Chrysler Automobiles. The Big Three are now the Big Three plus one tiny carmaker in California that investors think will take over the world.
Tesla is also on the verge of launching its Model 3 mass-market vehicle, Tesla’s most hotly anticipated car since the Model X SUV, which arrived three years late, beset with production issues.
But despite all that, you can, of course, argue with the numbers — because the numbers are ridiculous and getting more so every day.
A flashback: About two years ago, when Tesla was trading above $US250 per share, a sensible thesis that all the automaker’s immediate future growth was already priced in emerged. If you’d heeded that wisdom, you would have been both accurate as far as Tesla’s business goes — Tesla sold more cars in 2016 than 2015, but not that much more. But you also would have missed out on the big rally of early 2017.
This raises the obvious question, “How did $US100 per share of growth arrive while the actual business improved only modestly? (The company has posted only two profitable quarters in its history, largely by selling zero-emissions credits.)
The answer is sort of complicated and simple at the same time.
It’s complicated because Tesla has become a car company that also sells energy storage systems and in 2016 took over struggling solar provider SolarCity. Oh, and there’s chatter in the analysts’ community about how Tesla can create a multi-billion-dollar business by linking up its self-driving Autopilot technology and the data it’s gathering from autonomous miles driven under the umbrella of a ride-sharing/hailing operation known as the “Tesla Network” or “Tesla Mobility.”
Pointedly, this business doesn’t exist yet. Tesla is also talking about pickup trucks and semis, but let’s not go there.
Trying to figure out what all this is worth is immensely tricky, and you could say that some bulls are pulling their valuations out of places that aren’t fit to discuss at a family dinner. But there’s a far simpler explanation for Tesla’s massive increase in value: Investors aren’t spending well over $US300 per share to buy a claim on future profits, of which there are unlikely to be any for half a decades — they’re buying a claim on a future story.
The Tesla Story
Perhaps more accurately, investors are betting on future chapters in Tesla’s story. The early part of the Tesla book has already passed. If you bought in at any point in the past three years, you overpaid monumentally relative to the true believers who took a chance on Musk & Co. back when shares were at $US25 and the company was lucky to sell a few thousand cars a year.
However, there’s a problem with that. Since roughly 2010, Tesla has executed in such a way that it defied expectations, even as it was serially overpromising and underperforming. Effectively, all it had to do was stay in business.
Instead, it won Motor Trend’s Car of the Year award in 2013 for the Model S sedan and grew its sales to 2016’s high-water mark of around 80,000 — a decent jump over 2015 and more than double 2014.
At no point during this period did the company execute particularly well. The Model S endured early production issues, the Model X was plagued with production problems (“production hell” was what Musk called the first six months of 2016), there were big recalls over piddly problems, and in mid-2016 a customer died in a tragic crash while his Model S was on Autopilot.
It’s not like Tesla wasn’t trying. The company was in a full-on mode the entire time — jamming hard to meet yearly production goals. But the company was digging as deep as it could just to fall short of its own guidance and build cars that, while impressive in terms of performance, weren’t initially up to par with the rest of the industry on quality or reliability (they vastly exceeded it, however, on brand loyalty, proof that people were buying the Tesla story both on Wall Street and at Tesla retail stores).
If Tesla were Nigel Tufnel’s guitar amp, the company would have been turned up to 11 a long time ago.
Going beyond 11
There’s no 12, so Musk has decided to reinvent the amp … er, Tesla factory. Transformative automation of the manufacturing process will enable Tesla to transfer the enviable, unrealized margin it gets for the Models S and X — around 20% — to the Model 3, a car that will be hard pressed to net 20% more than it costs to build.
You could argue that Tesla’s present value, given its cost of operation against its revenue, is at best zero and at worst a negative number. That would be unfair because Tesla has physical assets, intellectual property, and a measurable cash flow, as well as vast goodwill in the brand.
But the market cap isn’t zero. It’s about $US55 billion. So what you’re buying now if you buy Tesla’s stock and its story is the company’s ability to successfully defy its execution limits and dramatically ramp up production in the future. The execution needs to defy the laws of physics — and Musk knows it.
That’s why he’s of late become preoccupied with manufacturing. He literally wants to reinvent automaking so Tesla can build a million cars annually by 2020 and not have to do it in a place governed by physical laws that are different from those in the known universe.
I’ll concede that if he pulls it off, Tesla could legitimately be valued well beyond what it is today. But even if he does pull it off, it’s going to take more than a decade. And at its core, Tesla remains a car company, constrained by all the same things that constrain other, more established car companies.
Changing the tune
Every time this realisation catches up with Tesla, it morphs into something else: an energy company, a solar roof supplier, a mobility company. But stories are easy to change. The laws of physics are much harder.
Tesla tends to be at its worst when it encounters basic obstacles. It doesn’t meet its delivery guidance because it just can’t bolt together enough vehicles. It faces recalls due to simple components because it is located in California, distant from the automotive supply chains of the Midwest and South. It doesn’t make a profit and runs lean on cash, so it has to use Wall Street as an ATM and periodically sell off chunks of itself, as it has to Daimler and Toyota and more recently did to Tencent.
Tesla is at its best when it’s actively pursuing Musk’s vision — to free humanity from its dependence on fossil fuels. Essentially, to save the world. To a large extent, that’s what has really made Tesla worth more than GM, Ford, and FCA. World-saving isn’t in Detroit’s wheelhouse.
But think about this: While Tesla has proven that a new car company can be founded in America — something the auto industry thought was impossible — it hasn’t come anywhere near saving the world. The global market for electric cars is still only about 1%. Tesla always overpromised and under-executes, because it can and because Musk thinks there’s nothing to gain from selling 80,000 in 2016 or 800,000.
As long as Tesla is selling lots and lots of cars someday, then it’s worth $US50 billion today. Investors are ignoring this, and it the short term, the risk that will get burned by Tesla’s tendency to execute poorly will catch up to them.
Get the latest Tesla stock price here.
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