Last week, before Tesla's (NASDAQ:TSLA) earnings release, I wrote two articles, Tesla: Very Disruptive and Extremely Irrational and Tesla's Extremely Irrational Price: Part 2 With Bull Case Scenario, making my case that despite the company's very innovative and disruptive concept, that Tesla's share price was also extremely overvalued.
Before I jump into my main argument, I will again repeat that Elon Musk is a visionary and there is no question that Tesla is and will continue to be an extremely successful company that will peel off market share from the traditional ICE market as the BEV technology continues to advance. The BEV market will continue to grow significantly over time as consumers continue to appreciate the advantages that come with owning electric vehicles. The fact that Tesla's Model S, even at its base price of $70,000 will sell almost 42% of the U.S. BEVs in 2013, according to my estimates, while being production constrained, is a testament to their success and to say that Tesla is not disruptive is pure fallacy.
Now that we got that out of the way, we can jump into my main argument and that is that what we saw following the earnings call on November 5th and during the trading hours on November 6th, a decline of 15% in Tesla's stock price, is only the beginning of its plunge towards its fair value.
Let me explain why.
Since Tesla actually beat their top line and bottom line expectations, car order expectations, guidance expectations, etc., it seems peculiar that the stock plunged by 15% following earnings and guidance.
But that's not actually what drove down the price. To understand what drove down the price, we have to understand what drove up the price in the first place.
Momentum and high frequency traders appeared to have traded the stock to obscene levels, giving the perception that investors believed that the company will be doing supernatural things in the later years of its existence.
During the first quarter of 2013, trading appeared healthy in the $30-$40 range. Average daily volume: 1.7 million per day. Between late March and early November of 2013, as the stock began making louder upwards moves, the share price more than quadrupled (that's right +400%)! Average daily volume: 10.2 million per day, almost 6X as much as the average volume during 1Q13!
While it's difficult to tell who exactly was trading the stock to these levels, the sheer increase in volume was quite noticeable indeed. One aspect that seemed very attractive to momentum traders: the extremely high short interest (33% of float as of October 15th) that could provide a sizable short squeeze, further propelling the stock up. These are gamblers and short-term speculators layered on top of real Tesla investors.
So now that momentum traders have taken Tesla to lofty levels, what exactly did they do to Tesla's valuation? Is it fairly priced? No. In actuality, at this price, Tesla was expected to destroy near-term earnings with some sort of a magical performance and meet or beat very lofty longer-term expectations by say 2020 just to trade at its current price.
But that didn't prompt many of Tesla's cult investors to dump the stock as momentum traders brought it to these difficult-to-explain levels.
Instead, they defended it. Ok fine so the investors did believe Tesla would be doing supernatural things in the later years of its existence. Their rationale? Many Tesla investors believe that by introducing the Model E at its lower price point, Tesla will be able to compete directly with ICE on price and that the current and near term forward Model S sales will pale in comparison to the Model E. Add to that the Model X sales and its international expansion and you've got the possibility of explaining this stock price at its current levels - with the possibility of huge upside, right? Wrong.
As I explained in an earlier article, expectations of the next-gen Tesla E have been absolutely outrageous at this price per share. Tesla would have to fulfill over 200,000 annual Tesla E orders by 2020 just to trade at the levels at which the stock was trading earlier this week.
This is not taking into consideration a great deal of risks facing Tesla. Besides for the economic, competitive, and political risks, which would certainly set the company back, what we learned from the earnings call on November 5th is that there could also be enormous supply challenges facing Tesla in the longer-term, even if there is that amount of demand for their vehicles.
Additionally, while it's admirable that Musk thinks that international expansion would be a breeze, that he can price his Model-E vehicles at $35,000 in the year 2016, and still maintain gross margins that traditional ICE companies would envy, in the world of reality, he is not taking into consideration the very real competitive risks that will soon arise and create some headaches for him and the company.
By his own admission, Tesla will be helping Daimler (OTCPK:DDAIF) launch a Series B class that Musk calls "the biggest electric vehicle program in Daimler history." He added that "it would be the most compelling sort of four wheel electric car in the market." How would this Series B constrain demand for Model E by 2016? Will Audi and BMW begin competing more aggressively as well once the BEV market expands? These are important questions that Tesla's investors need to answer.
Additionally, there exist the risks of suppliers, such as Panasonic, raising prices if demand from competitors begins to pour in. This, in my opinion, is very likely to happen and it would create margin pressure for Tesla. The result would be to increase the base price of the Model E or face margin compression. So I will say it now. Despite the fact that Musk thinks he can set the Model-E's base price at $35,000 in 2016, in actuality, the base price will be north of $40,000 by the time it's ready for production. The ASP of the vehicle will be closer to $50,000 with options. This would greatly reduce the market opportunity and some investors' lofty expectations.
Conclusion - What Comes Up Must Come Down
Now that the stock has had a mini-crash, you would think that some have scaled back expectations, discounted their models, or projected more conservatively. Perhaps.
As momentum traders are now dictating the terms of Tesla's stock price, the stock could easily become more volatile in the coming weeks and could continue to decline, which would prompt stop-losses to trigger, investors to take profits, more momentum traders to short the stock, etc. It's a cycle that will undoubtedly have a significant negative effect on the stock's near-term price.
But I doubt it will stop the likes of Green Energy Addicts from thinking that at $500, the stock would be trading conservatively.