Are You Valuing This 'Auto Company' All Wrong?

Oct. 9.13 | About: Tesla Motors (TSLA)

There aren't too many people that would argue Tesla (NASDAQ:TSLA) is cheap, or even fairly valued for that matter. When you compare it to the likes of Ford (NYSE:F) and General Motors (NYSE:GM) you can see a clear disconnect in the valuation within the auto space. However, growth and expectations must be accounted for, because in many ways, Tesla should not be compared to auto giants, but rather an emerging company in the biotechnology space.

Tesla's way overvalued!

In the last four quarters, Tesla has earned $1.32 billion in revenue, and during this period, its stock has increased by more than 500%. With a market cap of $22 billion, many are projecting major doom and gloom scenarios for the stock.

Despite only selling right around 10,000 Model S units in the first two quarters of 2013 - compared to 1.9 million for General Motors through September - Tesla's market capitalization is 40% of General Motors. This fact is the base for most bearish outlooks, others include:

  • Tesla needs to raise money for capital expenditures over the next five years.
  • Tesla is yet to produce a profit despite environmental credits.
  • Tesla is now facing high-end competition from the likes of BMW.
  • Tesla has just one manufacturing facility and a limited number of charging stations.

Essentially, Tesla's problems are similar to any company with a great deal of demand and a limited amount of supply. In the future, finding balance will be crucial to determining Tesla's fate.

Valuing expectations

So, with the noted concerns, operating margins of negative 16.4%, and a price/sales ratio of 17.7, what possible reason might investors have to either buy or hold this stock?

To answer this question, you must change your perception of Tesla, and not compare it to large well-established companies, but rather rapid growing companies that also have a bright future. In order to do so, let's look at a few biotechnology companies, particularly Regeneron Pharmaceuticals (NASDAQ:REGN) and Alexion Pharmaceuticals (NASDAQ:ALXN).

Now, clearly Tesla is not a biotechnology company, but the basis for its valuation might be more comparable to the variables used to value such companies. Both Regeneron and Alexion trade over 17 times sales. Meanwhile, the healthcare industry itself trades at a multiple of three times sales.

The reason that both Alexion and Regeneron trade with such lofty multiples is because of expectations. Alexion markets and develops Soliris, a drug FDA approved to treat two rare diseases, both genetic and blood disorders. However, Soliris is also being developed to treat five additional rare diseases, and analysts project that sales could top $5 billion annually! Therefore, despite Alexion's current revenue of $1.32 billion, investors buy on the outlook of future growth and development.

The same is true for Regeneron, a company that markets three products and has a pipeline full of potential blockbusters. Eylea, a drug to treat diseases that cause blindness, is its best-selling product, but many analysts believe it could eventually top $3 billion annually.

Then, the company has a cholesterol lowering drug that produced far better results than Lipitor, and an asthma drug that actually treats the disease rather than the symptoms, both in late-phase testing. Thus, much of Regeneron's $31 billion market capitalization is not tied to its $1.74 billion in trailing 12 month revenue, but rather future revenue and its likelihood of success.

In biotechnology, companies are often awarded multi-billion dollar valuations before ever selling one product. Pharmacyclics (NASDAQ:PCYC) is seeking an FDA approval for its leukemia/lymphoma drug ibrutinib, and despite the drug not yet being approved, the company already trades with a market cap of $10 billion, $138 a share.

Not to mention, analysts continue to upgrade the stock. Just last week, Deutsche Bank called ibrutinib a "best in class" drug, with the potential to transform the treatment of many blood cancers. Along with this statement, the firm has a $170 price target on the stock, insinuating massive upside from this point forward.

How do these industries connect?

Now, I know that biotechnology and auto are two completely different industries that are valued on various factors. However, when you begin to understand the valuations of such biotechs, you realize that Tesla's valuation might not be so absurd.

Moreover, retail investors must realize that Tesla is valued more so like a biotech versus an auto company. Tesla may have only sold 10,000 units in the first two quarters, but with projections to eventually surpass one million units annually, Tesla could support its valuation. In retrospect, Tesla's valuation might be like that of Regeneron or Alexion, waiting for sales of blockbuster products to materialize.

With that said, I am not suggesting that Tesla is a good buy, but rather providing an argument to the typical bearish outlook based on valuation. Clearly, Tesla is not being valued on its current sales, but rather its outlook, and in that case, Tesla's performance, market capitalization, and outlook is more like that of a biotech than an auto stock. Whether or not it meets those high expectations is to be determined, and will soon be known.

Disclosure: I am long F, REGN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.