Last week I wrote a piece about Tesla's (TSLA) innovative and disruptive, yet also visibly attractive battery electric vehicle (BEV) concept that has created an extremely successful alternative globally to the internal combustion engine (ICE) concept. There is no question that Tesla has been, is, and will continue to be an extremely successful company that will peel off market share from the traditional auto market that now also includes hybrid-electric vehicles (HEVs), plug-in hybrid electric vehicles (PHEVs), and extended range electric vehicles (EREVs). The BEV market itself is continuing to explode as consumers consider many of the advantages that come with owning electric vehicles.
In the above-mentioned article, proud Tesla Model S owners shared comments about their personal experiences of owning Tesla vehicles and their satisfaction with the product. I was actually quite impressed to see that Tesla created brand ambassadors to represent their products through their actual customer base.
That is absolutely a sign of success.
At the same time, just because a company is extremely successful, powerful, and disruptive doesn't mean that their stock is currently trading correctly. Here are some examples.
The Other Disrupters
eBay (EBAY) was the disruptive technology behind e-commerce. In fact, E-bay now owns one of Tesla CEO Elon Musk's breakthrough products, Paypal. For all intents and purposes, the company was absolutely disruptive with very few challengers. Despite the fact that E-bay was one of the few technology companies that by 2004 traded above its pre-Nasdaq bubble peak, even this successful company was not immune to challenges that would come before it. From the end of 2004 until the end of 2008, the stock would lose 75% of its value.
Another company, Netflix (NFLX), changed the way we watch shows and movies through its subscription-based internet streaming service. The stock had a cult following that ferociously defended its value from its $50 per share price in 2010 all the way to its $300 per share price in mid-2011. The story also ended in a 75% stock price drop in a few months' time. The stock came back and recently traded as high as $390s on a successful strategy that offers original content, such as House of Cards and Orange is the New Black (interestingly enough, Netflix pointed out that it's their non-original content that generates "a bigger percentage of overall Netflix viewing"), but then surprisingly, the shares collapsed again to the $320 range in a few hours' time, a drop of 24%. Reed Hastings, Netflix CEO, recently reflected on the recent success of Netflix's stock in the following warning to analysts. "We have a sense of momentum investors driving up the stock price more than we might normally. There's not a lot we can do about it. But I wanted to honestly reflect upon that."
Sirius XM (SIRI), through its disruptive satellite radio system transformed the way we listen to radio. I hate to give this example because it's also correlated with the Nasdaq bubble, but it's an extreme example of how prices can be inflated in the near term. Since Nasdaq peaked in 2000, Sirius has lost more than 90% of its value.
There are many other examples of disrupters whose share values collapsed at some point after a strong run up. Of course these companies are very different than Tesla and people can write volumes about the differences between the abovementioned companies and Tesla, but the point is, no company is immune to challenges in a competitive environment.
"The stock price that we have is more than we have any right to deserve."
Rarely do CEOs warn against their appreciating stock values, and in this case, with his enormous stake in the company quintupling over a year's time, the CEO left many in Tesla's shareholder community scratching their heads.
Back to my Baseline Model
First, I'd like to point out that my article was actually widely misunderstood by many readers. They focused more on my projection model than the point I was trying to make, which is that projecting what happens in 2020 is the irrational part of this whole exercise. You're guessing how many Tesla Model E cars Tesla will sell (which will be the bulk of their sales) in years 2016-2020 before a prototype has even been created. If you want to project how a company will do in 2014 and 2015 - that's absolutely reasonable. But guessing how much money a company will make 5 years from now with a car that they don't make yet is quite unreasonable in my opinion (especially since it will be the bulk of their volume). A lot could happen between now and 2020.
One of the items that was particularly criticized by commenters in my previous article was my low estimate of the next generation vehicle, Tesla's Model E. As the critics correctly pointed out, at its lower base price, which could be estimated at the high end of the $35,000- $40,000 range (my estimate is that the ASP will be closer to $45,000-$50,000 when you include options), it could absolutely be true that the Model E will be much more competitive with current ICE vehicles and therefore will have a much more effective relative penetration rate in terms of total volume than the previous Roadster or the current Model S. My model estimated that the Model X and E would account for 90,000 vehicles sold, which would result in a lower price target than the stock is trading at today.
A Bull Scenario
I will try to bring my point home using a different perspective. First, I will mention again as I did in my prior article that the bet at this point is strictly on the automaker to ignite demand for its automobile unit, not on its development services unit, which at least now is entirely devoted to Daimler (OTC:DDAIF) and Toyota (TM). This time, I will create a bull case scenario, presented below, in which we can assume that Tesla will sell 220,000 Tesla Model E vehicles by 2020, which is above current street estimates.
That would mean that they would sell 156,000 BEVs in the U.S. alone and capture 32% of my projected BEV U.S. market (a very generous estimate considering Tesla currently has a market share of 42% with very few players and almost none in their price range). The Model E ASP (which is higher than your base price because it includes options) will be $45K and the Model S and X ASP will be $90K in the U.S., and internationally, the prices will be $50K and $105K, respectively. In 2020, ASP would then equal $55K (between the S, X, and E), revenues would hit $15 billion by 2020. At 20% gross and 10% operating margins, the company would generate $1.2 billion from its auto unit in net income. With an estimated 160 million shares outstanding by 2020 and 22X earnings (way above industry average), the stock would be trading at $166/share, which is about the same level it trades at today.
Here's the problem with this scenario and the point I was trying to make in my earlier article. You're not trading at 2014 or 2015 forward multiples, which are usually more predictable. Instead, you're wagering your hard-earned money on the less predictable 2020 forward multiples, which you assume are correct. Even if Tesla does sell 220,000 vehicles in 2020, you're already trading at the 2020 price today. That's before discounting for your potential risks that could come in the form of competitive, economic, political, supply, beta, and all sorts of other risks (I didn't discount in my model above) that could come between now and 2020. Your only opportunity for upside is if none of these risks occur, no barriers to entry exist (which is absolutely false), that Tesla becomes a quasi-monopolistic BEV player, and if today's bull case scenario about a vehicle that hasn't even been created yet are wrong.
I am no Tesla hater. I am no Tesla basher. In fact, I think very highly of Elon Musk and Tesla. I think very highly of all that the company has accomplished and I am a huge proponent of the BEV market.
But I am also an investor who likes to calculate my risks carefully and trade intelligently. Using such a strategy, I lost relatively small amounts of money between 2007-2009, and my portfolio has done quite well since. What many Tesla shareholders fail to understand is that you can believe in the success of a company and its management, but also believe that the company's current market value of its price per share is trading at irrational levels and is overvalued.
What I've presented here is not a "Tesla bashing" as many commenters labeled my prior article as. Instead, I offered a perspective about Tesla's share price that seems to be possibly shared even with Tesla's CEO. The Tesla bulls should not think of my perspective as a war on their stock, but rather as an approach to view the stock through a more conservative lens (though I don't even think I am being that conservative).