A few weeks ago, I put a deposit down on a new car: an electric Tesla Model X.
With any other car – short maybe a Lamborghini Veneno – that revelation would hardly elicit a second thought. But insert "Tesla" in the sentence and suddenly a lot more people have a lot more to say. To some, it's positively exciting – another of a thousand cuts to be delivered to the smog-spewing engines of the last century. To others, it provokes an exasperated sigh, as they see yet another green crusader dump money into a hopelessly impractical invention.
Of course, when you live in an ultra-cold state like Vermont – and in a hilly, snowy, pothole-laden, dirt-road-filled ski town, to boot – as I have the past few years, those reactions are all the more justified on both sides. Vermont is, after all, renowned for its unspoiled natural beauty, and is home to many a protective soul set on defending Mother Earth even if it means biking to work in a blizzard. I do not count myself among them, if we're being honest, but discussing my potential next car seems to elicit a great deal of praise.
Vermont is known for its rough winters, with 300 inches of snow not uncommon in my area over any given winter. Much to the chagrin of electric-car enthusiasts, cold weather has a tendency to take a major toll on the performance of an electric car, making the batteries far less efficient. I once briefly looked at buying a Nissan Leaf, months before its release, and the company outright refused to even consider selling one to me for exactly that reason (not that I would have actually bought one, for the much simpler reason that it turned out to be such a sad little car – more on that later).
All this chatter about the car – which I have until 2014 to change my mind on, as the company isn't even delivering them until next year, and the deposit is refundable – has crossed over with my investing life as well. As I browse the news about technology companies, I see a new analysis on the publicly traded, fledgling electric-car company at least daily. The level of noise has increased appreciably: first, following the delivery of lots of Model S sedans earlier this year; and second, on the news that Tesla has now made it around the bend.
It's not uncommon for the stock (which was trading at about $30/share just weeks ago) to see price targets flung about of $500/share or even $1,000/share. Between that and the immense percentage of the shares outstanding that are short – nearly half the float (47%), with a full 23 days to cover at last count – the stock seems to be taking off like a rocket ship of late, flying past $50 per share. It's a short-term trader's dream: that kind of volume with that kind of volatility and a boatload of squeezable shorts to milk. But I'm not a member of the day-trading set, so…
All of this left me wondering: Just how much is Tesla, the company, really worth?Which is exactly what I will explore below (if you want to skip right to the numbers, click here to jump to the break.
Before I go on to that exercise, let me provide some context on my mindset headed in to this adventure. After all, a guy who just put a down payment on a car is now going to tell you what he does and doesn't like about that company's stock – is there an agenda here?
You will of course judge for yourself, but I would say "no." Despite my early adopter move to grab one of the first electric SUVs – my one bow to practicality in this adventure, as I have to cart around a couple kids and their many accessories through a slippery winter, and the Model S sedan is just not going to cut it, even as a second car (which it would be) – I would not classify myself as a "believer." I can barely be bothered to sort the recycling from the trash; I don't compost (much to the chagrin of my seven-year old son Sam, who seems to be getting a heavy dose of greenwashing in his second-grade curriculum); and I have no problem driving all around kingdom come in my current monstrosity of an SUV, which was probably an overreaction to ridding myself of the cramped hybrid that preceded it.
So what drove me (pun intended) to take the somewhat illogical step forward and write a check? Simply put, it's a damn nice car. One privilege of my life is that I get to try all sorts of crazy new gadgets, from cellphones to laptops and tablets to wacky prototypes of wearable computers and 3D laser scanners. That list has also included an occasional brush with a Tesla.
I'm not considering an electric car because of the environment. I don't think the internal combustion engine is inherently bad; nor do I have any illusions that my electric car – filled with toxic batteries and sucking power from coal plants and aging nuclear reactors – somehow magically has zero impact on the world.
I'd driven one of the first roadsters off the lot when Elon Musk came up to meet with a few of us at in the early days. The car – barebones in a way that somewhat resembled a Lotus Elise – wasn't exactly a pleasure craft. But it drove like strapping yourself to a silent rocket. Later, I was able to preview an early Tesla Model S prototype at a New York-area event. Both times I was thoroughly impressed with the cars (and with the company's founder, a less-polished version of Richard Branson) in my brief encounters.
After observing the reception the Model S got in the controversial New York Times double review and the big endorsement in Motor Trend, plus hearing a few owners gush about their newly delivered cars in the media, I had to seek out the final version and see for myself how it turned out. All I can say is, "Fantastic."
- The Telsa S is as well built as any luxury car on the market, outside maybe of a Rolls Royce or Bentley. But it's certainly as nice as a high-end Lexus or Mercedes.
- It's simple to charge up. For someone willing to put out a little pocket change (relative to the price of the car) on a better charger and some new wires in the garage, it charges up rapidly enough to allow me to use it every day of the week. For the occasional long-term road trip, I've got another car already.
- It's just plain fun. The car is a blast to drive, a huge plus in my book. The informatics are top notch. All in all, it gives me the kind of joy that few other cars can provide today.
It's a great car. I am an admitted, old-fashioned American lover of all things car. And so I decided to raise my hand for one. Now I find myself 3,268th in line for a vehicle that won't even be delivered until next year. You won't find me doing that for an Acura or a Cadillac, that's for sure. And that says mounds about what lies ahead for Tesla.
In reality, there is only a slim chance I will go forward with the purchase – all that talk about practicality will likely catch up with me. But in the meantime, there is much to be discussed about the future of the automobile and its most controversial new player.
Chief Technology Investment Strategist
What Is Really Worth?
, Chief Technology Investment Strategist
One thing I've learned about investing – and life – over the years is that hindsight has a tendency to show us just how silly many of our assumptions were, and just how bad we are at predicting how the world will turn out. Where, after all, are the flying cars and robot butlers the year 2000 was to bring?
So, to assess the realistic possibilities for Tesla's valuation, let's take a hypothetical look back at the company, from the near future. Just what might Tesla accomplish by the start of the next decade? Let's imagine (using assumptions from articles like this one and this one):
2020 was an amazing year: The election of the US's first female president. The release of iPhone 9. 's direct brain implant: Borg. The return of monarchy to our neighbors up north, and the fabulous Canadian Royal Wedding. And of course, the continued explosion in demand for electric cars, with market leader ' Model Q the undisputed best seller in its category.
It's hard to believe that it wasn't until nearly the midpoint of the past decade that the electric-vehicle market was anything more than a niche curiosity, far outside the consideration of the average carmaker. In 2012, Toyota – maker of the popular Prius hybrid – flatly declared it was no longer pursuing an electric car, because the technology was "not aligned with driver needs."
Sure, there were small fleets of electric vehicles being deployed for local commercial delivery and trucking, sales, and service fleets, and the like, but sales were still just a small fraction of the total market.
Back in 2012, the electric-car market totaled a mere 3.38% of the 14.5 million new light-duty cars and trucks sold in the US that year (and at the time, America was the world's largest car market and the one with the highest electrical vehicle penetration). Of the roughly 487,000 electric vehicles sold, the overwhelming majority – about 89%, or 434K – were traditional first-generation "hybrid" cars that didn't even plug in to charge.
Plug-in hybrids that could charge at home or work made up another 38.5K units; and vehicles powered solely by battery numbered a mere 14K, or 0.1% of the car market in the US.
So how did we end up – just eight years later – with Tesla as the fastest-growing major car brand in the world, with more than one million units expected to sell this coming year?
While few realized it at the time, 2013 was a watershed year in the development of the electric-car market for many reasons, not the least of which was the continuation of the trend established in the year prior. Those 2012 sales numbers might seem paltry by comparison to the global car market of the time, which topped 80 million new light-duty vehicle sales for the first time ever. But unbeknownst to all but the closest industry watchers, those sales were just beginning a rapid turn upward.
The real watershed moment in Tesla's history – and that of the electric-car market – came in 2013 with the release of the much-anticipated Model S electric sedan. Despite the negative press surrounding the safety issues of lithium-ion batteries as a result of 's use of a flawed large-cell battery design in its 787 Dreamliner, Tesla's sales out of the gate were not slowed at all. In fact, in its first quarter of sales for the Model S, the company was able to ship 4,750 vehicles, surpassing its two serious competitors at the time without a dealer network or a billion-dollar advertising budget.
The Model S release moved the company out of the miniscule high-end sports-car market and put it head to head with Mercedes, BMW, Audi, and others in the luxury-car market. The battery-powered car with a $57,000 to $105,000 price tag was well received by most of the automotive press, grabbing the coveted "Car of the Year" award before even being delivered to customers.
So here we are today, in 2020, with now on pace to double its 500,000 new-car sales/year in 2019, to an estimated one million cars shipped by the end of 2020. When it reaches that number, Tesla will become the first car company in history to attain that level so quickly, only 13 years after its first customer delivery. It will also pass a number of the Asian auto manufacturers – such as Geely, Chery, Tata, Saipa, Chan, and Beijing Auto – and become the 17th-largest automaker in the world.
It also places the company within shouting distance of much more widely known names, like Mitsubishi, Mazda, BMW, and SG, the makers of Mercedes.
Amazingly for original shareholders, Tesla was also able to make the climb without having to raise any additional capital by selling equity in the company, without any stock-based compensation, and without otherwise diluting shareholders. The company borrowed responsibly, maintained a strong credit rating, and has been profitable since 2013.
Without any major financial catastrophes on the books in the last decade, the ride forward for the company's stock has been nearly as straight up as the sales of its cars. Like many growth companies in their early years, investors have assigned a strong multiple over the company's earnings to the stock price, averaging about 40 ever since the company became profitable.
This – on the back of $3.2 billion in profits generated last year, thanks to the sustained average selling price of $75,000 per vehicle – pushed the company's stock over $1,150/share for the first time last week, making Tesla worth more than $130 billion in market cap, three times the size of Ford.
That glorious vision of the future, according to the many very positive articles fueling demand for the stock, depends upon: a ramp-up of sales to 500,000 per year by 2019; a sustained price/earnings ratio of 40; a sustained gross margin of about 25%; high average sales prices; zero dilution; no surprise costs (like recalls); and minimal CapEx costs, thanks to the large NUMMI factory that the company bought from GM and Toyota at the height of the economic crisis of 2008 for mere pennies on the dollar.
Give all due credit to the authors of those articles: If all of the assumptions in them hold up, then the stock could certainly be worth $1,000 or more per share, nearly 20x what it was selling for at the start of today's trading. However, any assumption is only as good as its probability. So, just how likely is the rosy scenario painted above? Let's break it down point by point, starting with sales growth:
Could Tesla Sell 500,000 Cars by 2019?
Compared to most other fledgling automakers, which rely on shared assembly plants or rented space from the big players, Tesla is much better off. In 2008, founder Elon Musk took advantage of the financial crisis to purchase and retool a state of the art GM/Toyota manufacturing facility called "NUMMI." In theory, NUMMI is capable of producing 500,000 cars per year.
If the company were growing sales at a rate of 71% compound annual growth – which is what it would take to get Tesla from an estimated 20,000 shipments in 2013 to 500,000 by 2019 – then securing financing for another plant would be a cakewalk, as these things go. Of course, there are only so many idle, relatively modern factories (NUMMI was built in 1984 and kept active until 2010) waiting to be purchased. So it would take a few years to get a new one up and running to capacity. Even if it could start building a second facility in two years (at a time when the company would only be using about 20% of its current capacity), it wouldn't be at full capacity by 2020. So there is likely to be a speed bump or two on that road to a million. But Tesla can definitely hit the bar before then, and doing so would make it one of the top 30 car producers in the world – not exactly Ford or GM, granted, but still an impressive feat.
So, check one in the plausibility box.
But one has to ask just how likely it is, too. True, the Tesla Model S is in a whole other league from its closest competitors today: the Chevy Volt ($40K sticker, with an electric range of 36 miles and gas generator to supplement it); and the Nissan Leaf ($28K now, after a significant price drop of $6,000 last month). However, looking at their sales may tell us just how elastic demand is for these cars:
If the Tesla is going to grow into a sales behemoth, it's going to first crawl before it walks, and prove it can shatter the ceiling imposed on most other electric cars: they have failed to consistently break above 5,000 units per quarter. Demand has remained relatively flat despite a $7,500 federal tax credit (your tax dollars at work distorting markets, mostly unsuccessfully) and big local tax breaks in places like Colorado and California. Up to now, Tesla has only shown that it can find a niche in that slowly expanding mini-market, with roughly the same volume as competitors. So a breakout is needed in order really to demonstrate the company's worth.
Assuming Tesla can actually buck this trend, it would need to drive demand at a heavy annual rate to get there. On December 31, 2012, the company boasted a total of 15,000 reservations for its cars. So far this year it has delivered 4,750, according to a statement ahead of earnings. Musk says the company has been getting new reservations at a rate of two for every car sold. (I'm not clear if that stat is hard math or hyperbole, but let's assume the former for now.) That means the company should exit Q1 having eaten one-third of the backlog of orders it had, and added another 9,500 to the list. Assume a 10% (very conservative) abandonment rate, and coming into Q2 it should have approximately 18,250 net reservations now outstanding. Only the latest financials will prove that out, but you can be sure the stock will move up or down based largely on that number this quarter.
Same with quarter-over-quarter sales, which need to rise 14.6% each quarter on average (as opposed to year-over-year quarterly numbers, which will need to rise 71%) to maintain the velocity toward that 500,000-car goal. These numbers are certainly possible in the short run – especially with European distribution coming in a few months, Asia coming online in 2014, the more family-ready Model X coming in 2014, and the viral nature of getting those first few units out the door to support interest for a short while, at least.
But that will be an impossibly lofty bar for a new brand still limited just to direct sales. Expect news about a dealership network sometime very soon, if there's to be true hope to reach this goal.
And watch those top-line sales numbers carefully, as Tesla's introductory success – selling high-priced cars to an indefinably sized market with years of pent-up demand – does not necessarily mean a rapid upward ramp.
What's more important is steady marginal growth for the Model S, which maintains through the introduction of Model X, and the eventual "GEN III" car, which is targeted at the mainstream market with a competitive midsize sedan price point.
Thus, for a few years that $75,000 average price will hold up, as the only cars the company has on the market will be luxury vehicles. However, as the company introduces lower-end cars such as the GEN III, average revenues per car will drop (as will margins, in theory). Thus, the many projections I've come across that assume revenue per car is stable are not feasible – not unless the Model S and Model X go on to become two of the best-selling luxury vehicles in the world, with sales rivaling all of Lexus. With its fleet of models and access to the extensive Toyota dealer network, Lexus only passed the 500,000 vehicle mark in 2007 (and never again since, though it's getting close once again).
Will the Market Keep Applying That 40 P/E Ratio?
Value investors tend to fear a price/earnings ratio above, say, 20 or so. In their world, the market is a perfect machine, and all earnings are created equal. But when you plan to own an asset for a long time, the math is less about what a company is earning today than what it can pull in in the future. So long as a company shows no signs of slowing growth, the market can award that company a high P/E ratio for a long period of time.
, for instance, maintained a high P/E ratio – well above 60 – for much of the first few years of its life on the public markets. , when it has been profitable, has traded at an average P/E well over 100 for the past five years. There is no hard and fast rule for setting P/E ratios.
That is only to say that high P/Es can be carried for a while. However, the truth is that there's very limited room at the top. Among all American stocks (excluding real estate trusts, which trade on different factors altogether), even at today's all-time stock market highs, only a handful of companies with multibillion-dollar market caps trade at multiples of greater than 35x current and forward earnings:
- Crown Castle International (CCI)
That's the entire list. Just seven companies above $2 billion in size command those multiples. Two are fresh off their IPOs in barely a year's time. And note that all of those companies are technology companies. Why is that important? After all, Tesla's got some serious technology going on, even if it is an auto company – batteries, semiconductors, all that jazz.
But one of these things is not like the other. And that thing is gross margins. Datacenters are expensive, but not nearly as expensive as building cars. These businesses are far less capital intensive, have no real necessity for debt, and generate much stronger margins. At , the gross margins are a whopping 94%; five of the others have gross margins above 70%. The one straggler, , has a 50% margin – but that can be forgiven since it built the massive datacenters Wall Street uses to do high-frequency trading, and thus are a darling among the stock jockeys.
Wall Street only confers huge multiples on companies whose costs are so manageable that their earnings growth will be leaps and bounds above that from another company taking in the same dollars in additional sales. As the saying goes, "30% profits are reserved for the Mafia and ."
Which begs the question…
Can Tesla Maintain Profitability as It Ramps Up?
Tesla, by contrast, will enjoy roughly a 25% gross margin by the close 2013 if all things work according to expectations. And that's thanks in part, of course, to the current state of the market: no dealership network; lines headed out for months to get the product; no years of backlogged cars on the road at risk for recalls; millions of dollars in cheap PR; and a number of other "honeymoon" conditions that will soon fade.
For comparison purposes, what does an established automaker manage? Luxury-car king AG (makers of Mercedes) enjoys gross margins of 21%; BMW has 18%; 14% for Toyota; 13% for Ford; and 9.9% for lowly GM.
As you can see, luxury-car buyers are far less price sensitive than when you start dipping down into the $30,000-car segments. There, with absolutely fierce competition and yet the same standards for fuel economy and safety, margins invariably suffer.
Tesla may find a way to maintain a 25% margin if it stays 100% luxury. Even then, it will take some time for it to enjoy the economies of scale in property and plant that the giants listed above enjoy. If Tesla goes down-market too early, it could see those numbers erode quickly... and that surely would spook the market away from those multiples we discussed above.
Still, don't fret too much if you're a Tesla investor. It's not just temporary conditions that led the company to grab such high margins so quickly – most startup automakers would kill for those numbers at the same size. On the plus side:
- Those federal electric-car subsidies aren't due to expire until 2016.
- Tesla still makes the only luxury electric cars on the block, and that won't change for at least a few years as we don't even have a prototype from any of its competitors, let alone a projected delivery date.
- Those down payments people like me put in Tesla's pockets months ahead of time, along with cheap government financing, give it a great working-capital cushion.
- The ownership of the NUMMI facility is the gift that keeps on giving. CapEx will be kept down for many years, while the company slowly builds toward that huge 500,000-car capacity.
Even as the company moves down-market with new models, it is still likely to be the only really practical choice on the block. The Leaf's far lower range and pure oddness limit its appeal dramatically. Even the recent mega price cut will only give it a temporary bump in sales. The Volt is growing, thanks to lots more incentivizing lately by Chevy, but it still suffers from a terrible PR hangover, the butt of jokes about spontaneous fires.
No other electric comes even close to delivering what the Tesla Model S does. And if the company can do the same in the lower price segment, it will have -esque lines queuing up for the next one, thereby maintaining much of that pricing power.
In other words, if any company has shown the marketing and operations acumen to maintain strong margins at such an early growth stage, even in this capital intensive business, it's this one. So don't go factoring too much risk into that equation.
But to do so the company will have to grow in a very controlled and methodical way – possibly at odds with the near-doubling each year many price models would require in later years. Musk has shown he'd much rather take the time to get it right. He's playing the long game.
Is There Really a Future with No Dilution?
Part of playing the long game is attracting absolutely unparalleled talent – and keeping it. In Silicon Valley (the birthplace of Tesla), that means stock options. Lots of them. It's a hallmark of techie culture: put in 20 hour days for a few years, and when we go public, you'll be rich! Now that they're holding a stock that's tripled since its IPO, some early Tesla employees are surely feeling that way already. But if those $500 and $1,000 stock prices really are possible, then that's all the more motivation to grab up every share you can.
That's the rub for outsiders like us: Paying employees with stock requires constantly issuing more of it, often at the expense of existing shareholders. Look at it this way: You have a company, and there are 100 shares outstanding. Cash is tight, so when you hire a new "rock star," you pay him a smaller salary but also give him 10 shares per year. Those shares don't directly cost the company anything – they are created nearly as easily as dollars at the Fed. But when it comes time to split up the profits, say, by passing out a dividend, then the pinch is felt. If the company made $50,000 that year and there were only 100 shares, the dividend would have been $500 per person. Add those extra 10 shares in, and the old shareholders now only get about $454. Boom, 9% less money in your pocket.
Even without a dividend in the mix, the math is the same: The more shares out there, the less profit per share. And when the profit per share drops – even if a company makes the same amount of money in total and the market rewards it with the same multiple in its price/earnings ratio – the share price drops too.
Tesla appears to be pretty heavy on the stock-based comp. Since its IPO in 2010, the share count has increased from 93 million to 114 million, a 22% jump.
Yet as it grows, the company will add even more employees, potentially increasing the amount of stock-based compensation, not decreasing it. If that proves true, the situation could become even worse.
If Tesla were to keep diluting shareholders 10% annually from now until 2019, that would nearly double the number of shares the company has out now, from 114 million to 200 million. That alone could cut the target price nearly in half.
It's a potentially significant price limiter, often unconsidered by the many models out there which completely ignore this quiet cost to shareholders.
So What's Tesla Really Worth?
Could Tesla be worth $1,000 per share in the next few years? Sure. But not likely.
Thankfully, with Tesla, all the operational ducks are in a row. You cannot say that about most growth-stage startups. If things stay that way, the only real barrier in front of the stock is gross unit sales. And predicting that – the combination of so many macroeconomic, social, and business factors – is like predicting the winner of the World Series five years out. You only have so much information, and before long it'll be out of date.
Even if all things go well, investors will still be subject to the normal forces of multiple compression and dilution, cutting a significant amount from those speculative forecasts. Once Tesla's market cap begins to approach that of Ford, Honda, Toyota, and other big-name competitors which sell more cars per month than even this wildly successful Tesla would per year, the comparisons will start flying, and quickly put a lid on that multiple.
In the case of a veritable revolution that sees Tesla producing at full capacity in five or six years and expanding still, even then the price is likely to be a quarter or less of those optimistic estimates.
However, even with less-than-stellar sales and a P/E that returns to earth over a few years of lowered expectations, it's very possible that today's $6-billion market cap will still look cheap. If the company can only manage to grow to 150,000 units of sales in that time and can eke out a net margin of 10% – right in line with its luxury-car counterparts, and about double the level of Ford or Toyota – it'll theoretically be generating about $1.2-1.5 billion per year in profits. In that scenario, the company would then be comfortably priced as a $15 to $18-billion market cap, with no big growth premium. That's still a very healthy return for investors, especially if dilution slows.
The worst-case scenario – the one that sees people losing money from today – comes about if the company flops in the sales department: The Q1 momentum – backed up after a year of pent-up demand for the only car of its kind – drops off rapidly, and the company finds itself stuck, like all electric carmakers before it, churning out just a few thousand cars/month. Or BMW, Mercedes, GM (whose Cadillac-labeled upgrade of the Volt is due to start appearing for preview sometime very soon), or Nissan comes up with something unexpectedly amazing. But don't underestimate Musk. If anyone will be there waiting to supply those drivetrains with open arms, it will be him.
Right now, it's Tesla's market to lose.
Bits & Bytes
What Happened When One Man Pinged the Whole Internet (MIT Technology Review)
HD Moore, the lead researcher at computer security company Rapid7, thought it would be fun to carry out a personal census of every device on the Internet. Using a stack of computers that occupy a spare room at his home, he sent simple automated messages to each one of the 3.7 billion IP addresses assigned to Internet-connected devices around the world. The data he collected from the exercise revealed some serious security problems and exposed vulnerabilities in business and industrial systems used to control everything from traffic lights to power infrastructure – vulnerabilities that could allow anyone to take control of them.
$500 Million Space Telescope Nearly Annihilated by Soviet-era Spy Satellite(Gizmag)
The Fermi Gamma-Ray Space Telescope (FGST) was launched in June of 2008 to help unveil the mysteries of the high-energy universe. Its mission was almost violently cut short last month. NASA's project scientist for the FGST, Julie McEnery, received an automatically generated email message on March 29 indicating that in six days, her satellite was on course to cross paths with Cosmos 1805, a Soviet-era spy satellite. The math said that the two satellites would occupy the same coordinates only 30 milliseconds apart, and that given the velocities and positioning of the objects, a collision would essentially ensure total destruction. NASA's only choice was to use the FGST's thrusters to try to dodge the oncoming Cosmos 1805.
Back Online After a Year Without Internet (The Verge)
Most of us couldn't imagine a day without the Internet, let alone a full year. For technology investors like us, the Internet and the World Wide Web are pretty much the lifeblood of our work-related existence. Read one man's interesting account of what it was like to spend a year unplugged.