Has Tesla's Valuation Looked Too Far Into The Future?

| About: Tesla Motors (TSLA)


Tesla is now incorporating a large degree of future growth into its valuation.

Future plans for the Gigafactory will require large amounts of capital that now exceed the company's current balance sheet.

Analyst estimates remain based on forecasts that extend nearly 15 years into the future.

Tesla Motors (TSLA) has become a story of innovation and endurance as the electric car company survived the Great Recession and outperformed competitors at every turn. Even now as the company faces unique challenges, Tesla has managed to capture the imagination of its investor audience. Tesla's share price over the past few months has soared as the company has come to embody the idea of innovation. However, the company's share price may soon be reaching a new ceiling as expectations have already come to incorporate much of the company's future growth.

Seth Klarman, American billionaire and founder of the Baupost Group, may be best known for his book titled "Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor." But in recent days, the investment guru has become an outspoken critic of the asset price bubble now forming in technology companies including Tesla Motors. As shown in the article found here, he stated that such companies were reaching "nosebleed valuations."

What appears to have alarmed Klarman along with a growing portion of the investment community ultimately comes down to the valuation being placed on future growth. For a promising company like Tesla Motors, there is an argument to be made that popular sentiment has begun to price in perfection prior to obtained performance. No greater can this fact be seen than in the recent analyst upgrade made by Morgan Stanley analyst, Adam Jonas.

In the report made by Morgan Stanley described in the article found here, Jonas estimates that by 2028, Tesla Motors should begin to sell over 1.1 million units of production. By looking nearly 15 years into the possible future, Jonas estimates that Tesla may one day sell less than 40% of the number of vehicles sold by General Motors (GM) in 2013. Nevertheless, despite these ambitious predictions of continued success, the price of Tesla's stock jumped more than 11% on the report - and market capitalization increase of more than $3 billion.

Tesla Motors now trades with a market capitalization of $30.11 billion based on the intraday price of $244 as of March 11. Today, Tesla now trades at over half of the $58 billion market capitalization of General Motors, the industry giant which produced over 2.8 million vehicles in 2013. This is despite the fact that Tesla only plans to build 35,000 Model S Sedans in 2014.

One significant element that has enabled this rapid share price acceleration has been the association of the company with high-tech growth. Jonas writes in the same report that Tesla could one day become a major competitor in the electrical grid storage business. He writes the following:

"Tesla's request to disrupt a trillion dollar car industry offers an adjacent opportunity to disrupt a trillion dollar electric utility industry"

As lofty as these ambitions may be, the fact remains that the company has yet to build out the infrastructure necessary to compete in such a clean-tech utility industry. Herein lies one of the more disturbing facts behind Tesla's futuristic plans.

According to the Wall Street Journal in an article found here, Tesla is proposing a battery "Gigafactory" that could cost up to $5 billion. Indeed, this plant would only enable the company to sell as many as 500,000 vehicles a year. Should it also be used to address the electric utility industry, it is clear that several of these plants will be needed in order to meet the 15-year 1.1 million vehicle estimate proposed by Morgan Stanley's Adam Jonas.

What makes this problematic is the necessary capital needed to build out the vital infrastructure. As of December 2013, Tesla only had total current assets of $1.27 billion, of which $849 million was in cash and cash equivalents. With $1.75 billion in total liabilities, the company maintained total shareholder equity of only $667.12 million.

Tesla is already proposing to raise an additional $1.6 billion through a bond issue to help finance the construction. The automaker said that it would contribute $2 billion to the proposed battery factory. Panasonic Corp alluded to the possibility that it would consider investing nearly $1 billion into the factory along with other Japanese suppliers. However this too falls short of the $4 billion to $5 billion needed for the plants costs.

At the very earliest, the proposed Gigafactory would open with its first production in 2017. However, adding additional investors onto the plan will dilute ownership of the facility. Additionally, Tesla's stock itself may be further diluted in order to help raise additional capital needed to build the battery plant.

The company expects to produce 500,000 electric vehicles around the year 2020. The large costs associated with the factory and the lengthy time needed for construction and plant ramping suggests that a second facility would be almost a decade away from being operational. Based on the 500,000 vehicle estimate, at least two such facilities would be needed to meet the analyst target just for the vehicle sales alone.

(plans for the proposed Gigafactory can be found here)

Whether Tesla could be built fast enough to disrupt both the auto industry and the electric utility industry is a subjective argument in itself. There remains far too many variables to predict success on the battery front prior to the factory being built. Even then, will there be enough capacity to address both markets? The one fact that does remain, however, is the significant amount of risk that these future plans entail.

Even before considering a second factory, the very first Gigafactory will increase Tesla's liabilities by $1.6 billion based on the proposed bond offer by the company. This essentially doubles the company's liabilities when compared to the past year. If Tesla invests $2 billion as its suggests, it would also halve the company's amount of cash on hand. All of this places a rather large emphasis for the company on a single facility that will not even be operational until 2017.

As of December 2013, Tesla carried total assets of $2.42 billion. The company still carries an annual operating loss of $61.28 million. However, Tesla's cash flow from operating activities has become positive as the company brought in $257.99 million in 2013. While the company had an operating loss for the year, it's $2.01 billion in revenue carried a gross margin of 22.7%.

Final Thoughts

Tesla's current valuation far exceeds the state of its current balance sheet. The company's large plans for expansion will require a significant improvement in order to meet its stated objectives. Ideally for the company, this may come in the form of dilution in order to leverage the premium share price now associated with the company. However, such action would inherently dampen the share value for individual investors.

It remains a rather tough sell to believe that Tesla could disrupt both the vehicle and electrical grid industries simultaneously without accounting for the costly infrastructure investments necessary to accomplish these tasks. While Tesla is making strides to address these issues, it comes at the cost of localizing risk onto a few key assets. Few need to be reminded that Solyndra's $300 million state-of-the-art facility served in its own undermining. This was largely due to an unpredictable and sudden shift in industry economics. Such is the potential risk for heavy investments in a less than established industry.

Tesla now carries a significant amount of momentum as it moves into a phase of business expansion. While it remains to be seen if the company can sustain the demand for its products, the company has successfully proven itself to be a worthy industry competitor in the present. With a nearly $30 billion market capitalization, long-term investors in the company would be wise to understand the premium now associated with the company's stock. Barring a significant inflow of unexpected capital, the company's future plans appear to be well factored into the stock's current valuation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: While I have no position in TSLA, I do maintain both long and short options in TSLA