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Summary

  • We have decided to perform a bull / bear analysis and valuation of Tesla. Unsurprisingly, the valuation range is wide.
  • Tesla is only a Buy if you assume that the company will deliver long-term margins at least in line with BMW or Audi (excl. the +5% company-specific margin tailwind).
  • In our view, this is a realistic assumption likely to be supported by the newsflow around model X next year.

The Bulls vs. Bears debate has been intense in recent weeks and months. Tesla (NASDAQ:TSLA) missed earnings expectations for the second quarter in a row in July and yet, the stock keeps going up.

Valuing companies, which deliver high revenue growth but limited short-term earnings, is always a difficult task. Comparative valuations notably are not reliable as the EV/sales ratio is the single ratio that can be used. But we believe that a DCF (discounted cash flow) valuation is pretty well suited to this kind of mission as it captures the long-term potential (revenues and margins) of any company.

As a result, we have decided to perform a DCF valuation of Tesla, actually three valuations (base case, bull case and bear case) to better assess the risk/reward.

Base case: 16% upside

We use a discount rate of 10.6% (with a beta of 1.35x) and make the following assumptions:

- Revenues continue to grow at a fast pace until 2024 as Tesla introduces new models and as consumers gradually embrace electric vehicles.

- In 2024, Tesla generates more than $51bn revenues (vs. $3.9bn expected in 2014) and still delivers a solid 11% revenue growth. For comparison purposes, BMW (OTCPK:BAMXY) is expected to report revenues of $103bn in 2014.

- The non-GAAP operating margin gradually expands from the 4.6% expected in 2014. From 2017, Tesla cruises at a 16% margin.

- We assume here that Tesla is likely in coming years to deliver margins in line with those of high-end peers such as BMW and Audi (around 10-11%) and to benefit from specific margin tailwinds we estimate around 5% (vertical integration as Tesla owns its dealer network, absence of legacy costs such as pension costs). It's worth noting that Tesla's positive non-GAAP margins in 2013 are an impressive achievement at such an early stage of the company's life and give credence to the mid teen operating margin contemplated by Tesla management.

- Growth rate in perpetuity is 3%, consistent with world GDP growth across different economic cycles.

We get to a $305 valuation, or 16% upside.

(click to enlarge)

Bull case: 59% upside

We use a discount rate of 10.6% (with a beta of 1.35x) and make the following assumptions:

- We have the same revenue assumptions as in our base case.

- From 2017, Tesla cruises at a 20% margin. We assume here that Tesla delivers margins in line with those of luxury car makers such as Porsche (margins around 15%) and benefits from specific margin tailwinds.

- Growth rate in perpetuity is 3.5%, consistent with world GDP growth across different economic cycles.

We get to a $421 valuation, or 59% upside.

(click to enlarge)

Bear case: 86% downside

We use a discount rate of 10.6% (with a beta of 1.35x) and make the following assumptions:

- Revenues grow at a slower pace than in our bull and base cases as new models are less successful, as competition intensifies or as adoption of electric vehicles takes longer than expected.

- Operating margin gradually declines from the 10.5% peak expected in 2015 and reaches a mere 5% from 2019 onwards. We assume here that Tesla performs only in line with traditional car makers as it faces intense competition in the high-end segment and significant price pressures, but still benefits from specific margin tailwinds.

- Growth rate in perpetuity is 2.5%, slightly more conservative than in our bull and bear cases.

We get to a $36 valuation, or 86% downside.

(click to enlarge)

Attractive base case valuation and positive newsflow to support the shares heading into 2015

At first sight, the risk/reward does not appear attractive: a 59% upside in a bull case does not compare well with an 86% downside risk.

That said, we believe that investors are unlikely for the moment to factor in the bull and bear assumptions we have detailed above. Indeed, it's probably too early to assume that Tesla could perform in line with Porsche in the long run as it plans to ship models for the "mass market" in a couple of years. And it's probably too early to assume that Tesla will lose its pricing power and the electric vehicles competition as the company has been delivering quite spectacularly in the last years.

In all, we would focus on our base case which points to a 16% upside and on the expected newsflow, which is expected to be supportive with the model X launch next year.

Source: Tesla: $421 Or $36? Pick Your Scenario