"It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a mispriced bet - that they can occasionally find one."
"Mimicking the herd invites regression to the mean."
While I have not sifted the world to find this misplaced bet, I have definitely sifted the U.S. markets thoroughly to find abnormalities. My recent search has come up with Tesla Motors (TSLA) as one of the most overvalued stocks I have seen this year. The above chart signifies the epitome of a herd like stock, the object of this article is to find out if it is warranted. So what do you need to have a significantly over priced stock relative to any reasonable fundamental valuation? You need a great story, in fact this story is so great it starts out in Hollywood, with the initial production of "Iron Man", featuring Robert Downey Jr. playing Tony Stark who is portrayed after Elon Musk, CEO of Tesla Motors. This gets the ball rolling, now add analyst hype, a great car (Model S), a quadrupling of the stock price, Elon Musk hype via twitter, and now you have a cult like following. While Tesla Motor may be masquerading as a tech company its true face is just a car manufacturer no different than General Motors (GM) or Ford (F). In fact they are so similar that Tesla Motor actually bought a factory off General Motors and Toyota Motor (TM). While many investors want to value Tesla Motors on bogus long term assumptions about 2014-15 revenues and profits, I want to value Tesla Motors rightfully as a car manufacturer.
|Qtrly Rev Growth (yoy):||17.62||-0.02||0.02||0.42|
|Gross Margin :||0.12||0.1||0.16||0.22|
|Operating Margin :||-0.33||0.01||0.06||0.08|
|Net Income :||-295.09M||4.72B||12.23B||N/A|
|PEG (5 yr expected):||76.03||0.66||0.33||0.72|
*All data provided from Capital IQ
I highlighted the large divergences from the above data, alarmingly Tesla Motor is trading at roughly 21 times the industry's price to book, and 54 times the average price to sales of the industry. All of this while continuing to burn cash at an alarming rate. To give readers the scope of how big the valuation divergence is, by utilizing the industry price to sales metric Tesla Motor would be valued at approximately $4.55 per share, & on an industry book value basis at $1.77. While I understand Tesla Motor is growing revenues faster than the industry, investors are paying a huge premium for that growth. With such a large premium currently priced in, even with above normal growth it is unlikely that Tesla Motor will grow into its enormous multiple.
Elon mentioned that Tesla Motor should be able to achieve margins similar to Porsche (OTCPK:POAHY), a manufacturer that has been around for over 80 years and produces annual profits of around $2 billion USD. Elon even mentions directly that profitability is unlikely in 2014, due to the cap ex needed for the Model X assembly. So while it is nice to hear the CEO make claims that they can achieve margins similar or better than Porsche it bears skepticism given that in the last quarter without the one-time loan benefit they would have only made half a cent of profit. While I think Elon is a great innovator and a nice person that wants to change the world for the better I think he may have bitten off more than he can chew with all these grandiose promises.
Tesla Motor Cash flow statement, 2010-2012
*All data from Capital IQ
If you look at where the funding is coming from it is mainly from shareholder dilution. Roughly $754 million has been raised in the last three years (Sale Purchase of Stock) along with roughly $1 Billion just raised recently which is a combination of convertible debt and equity, bringing the total capital raised from shareholders to approximately $1.75 billion. While Tesla Motor may have some cash left over after the government loan is paid off, it likely will not have enough cash to fund 2014 costs of the Model X development and the ambitious supercharger network.
While I could repeat all the risks presented in the Barron's article and many other articles I will just summarize some of the large risk factors I see affecting Tesla Motor .
- Tesla Motor niche remains a niche only business and struggles to grow sales past the five digit threshold.
- Musk's highly optimistic views on significantly lower battery costs don't materialize
- The nationwide network of superchargers significantly increases cap ex & drains cash flow
- The development of Model X, & costs overruns
- Long term issues relating to the 8 year full warranty on the battery, likely will result in huge long term costs to Tesla Motor
- Competition from manufacturers with significantly more scale & experience entering the EV market more forcefully.
- Lower priced competition already from the Volt, Prius, & Leaf dominate the low end market share, before Tesla Motors lower cost EV even hits the market.
- A significant portion of the stocks run was from short sellers covering their wagers & not from long-term investors
- Options & trading activity points to a day trading stock & not a long-term investment.
- If Tesla Motor was valued even remotely close to other car manufacturers it would result in a substantial decline in price per share.
While all these highlighted topics have already been mentioned in some regard, I think there is another substantial risk to Tesla Motor that exists with regards to giving away free power for the life of the vehicle. While on the conference calls no one has really addressed this long-term issue, I think it gets cumulatively worse over time and could become enormous given large scale. Think if Tesla Motor gets sales of say one hundred thousand a year and Tesla Motor has cars on the open road of say half a million in five years. Assume two full fill-ups per week you get 500K * 2 * $12.98 (using California as the base rate case) *52 equals costs roughly of $675 Million. Now I know that many of the stations have solar power panels on the roof, unfortunately the power generated from those panels only has enough power per day to charge less than a handful of vehicles fully.
"Nine stations now provide free electricity for Model S owners, and the company has said it wants 100 along U.S. and Canadian highways by 2015."
Now if you think that was a big cost just consider the fact that Tesla Motor is the only car manufacturer attempting to build out an exclusive nationwide network. The other manufacturers don't have to worry about spending more cap ex on a nationwide network as they are leaving that to local service stations. Given the annual costs (Cap Ex & Operating costs) associated with developing a nationwide supercharger network you would have to assume this is a competitive advantage for the incumbent players. Also another potential issue is even the supercharger network takes roughly 30 minutes for a half charge, so it is likely that the charging stations would be fully occupied when someone arrives. Which means that you could be setting aside a full hour of your day waiting for an open charging station. While this is not likely now, given there are so few Model S' on the road, it is likely a possibility as volumes increase.
Elon Musk describes his original purpose for Tesla Motor during his All Things D interview as an attempt to fill a void for people that love EV's, but that he never assumed Tesla Motor was a good way to, "get a return on investment". I would think that the primary motive of the CEO would have been to make a profit for the shareholders, however, apparently this never crossed Elon's mind. Then he goes on to describe his company as "quite a high market cap" and then chuckles, as if to imply that the stock is drastically overvalued. While these may just be subtle clues it seems like the last thing on his mind is achieving long-term profitability & returning capital to shareholders. Instead it seems shareholders are funding all the development out of their own pockets, riding on the aggressive assumptions from management that big profits are on the horizon.
Overall, I feel that Elon is a great person, who was tremendously successful with his PayPal startup, and wants to continue to innovate with Tesla Motor & SpaceX. However, I think there is a line investors must draw in the sand when the promises get out of line from reality. In my view Tesla Motor is priced for perfection, and even if they are successful with the Model X, the nationwide supercharger network, and the development of lower cost batteries, I still think the stock currently has priced in all of this. While most "investors" view this as a wait and see approach, I feel Tesla Motors needs perfect execution over the next few years just to keep the stock price where it is now.