Tesla Motors: The Case For A Short Position

| About: Tesla Motors (TSLA)

Summary

The Model S is a great product and the Model X may turn out to be just as great.

The Model 3, it it lives up to the hype, will probably be an even better product than either the Model S or the Model X.

Despite the great product line, Tesla is not making money and its valuation appears to be extraordinarily high.

This article attempts to put a valuation on Tesla Motors to answer the question "should I short Tesla Motors?".

Introduction

Tesla Motors (NASDAQ: TSLA) today offers a Model S and Model X and is working on a Model 3 with production start planned for late 2017 and deliveries likely in early 2018. I've seen and ridden in a Model S and it is truly a very impressive passenger car offering near silent operation along with amazingly quick acceleration when you mash the go peddle. TSLA has developed a great product in the Model S. The Model X may follow the S in popularity. The S appears to be targeted to the upscale family sedan buyer while the X is targeted to the equally upscale family mid-size SUV buyer. The Model S sells in a range of $75k to $105k - not exactly middle America prices. The Model X is priced a little higher falling in the range of $80k to $132k for the "Signature Edition." The Model 3 is planned to be a more affordable offering coming in at $35k before Federal rebates/subsidies.

So, Tesla's products are great. What is not to like? From an investor standpoint, Tesla's valuation is well in excess of anything that can be justified by current sales and is well in excess of anything that can be justified by a reasonable estimate of sales growth in the next 10 years.

What is Tesla Worth?

Tesla stock is difficult to put a value to today because it has negative free cash flow and negative earnings. However, we can look at some comparisons with other car makers to get an idea of whether Tesla stock is fairly valued. General Motors (NYSE: GM) fairly recently went through a "managed restructuring" or, in other words a bankruptcy, making GM not a fair comparison as it shed a great deal of debt during that restructuring. Ford (NYSE: F) managed to make it through the 2009 financial crisis without any balance sheet restructuring. While Ford and Tesla are very different companies today, if Tesla is going to significantly grow its sales and earnings, it will look a lot more like Ford in the future than it does today. Let's compare some of the numbers between Ford and Tesla.

Source: Author

So, what does this comparison tell us? On an enterprise value basis, Tesla is about one quarter the size of Ford but only generates less than 1/25 of the revenue. We can't compare EPS between the two because Tesla has had very few quarters when EPS was positive and for 2015 Tesla lost $2.30 per share. Likewise P/E is not comparable unless we look at a forward P/E based on Tesla's 2016 guidance and analysts estimate of earnings. In that case Tesla has a P/E of about 198 based on the analysts midpoint. That is a bit high even if you assume that Tesla is a high-tech company and not a manufacturer of automobiles. At a more reasonable forward P/E of 30 reflective of being a high-tech and high-growth company, Tesla's 2016 fair value should be on the order of $35/share.

If you consider that Tesla is more a manufacturer of automobiles, you might look at the price/tangible book value. Using a value of roughly 2 to 4 would put Tesla's current fair value in the range of $16.50 to $33 per share. We also could look at price/operating cash flow compared to Ford and come out with a current fair value for Tesla of $4.60. That is really low but when you consider that Ford's P/E is only 7.4, it makes some sense. If Ford's P/E was a more typical value of 12 to 15, its corresponding price/operating cash flow would be on the order of 5.7 to 7.1. Tesla in a comparable valuation would have a fair value of $7.50 to $9.40 per share. Clearly, Tesla currently carries a steep premium in its stock price.

Another way to look at Tesla's valuation is through a reverse Discounted Cash Flow (DCF) analysis. The only difficulty we have is that Tesla currently is losing money and that doesn't work well in an analysis. We can take a look at what growth rate Tesla would need to have to justify Tesla's current valuation based on a DCF analysis using the 2016 consensus EPS of $1.19. This is what it would look like.

Click to enlarge

Source: Guru Focus

Tesla, over a 10-year period, would have to grow its EPS (and everything else that went with it) by more than 45% per year compounded. And remember, Tesla's 2015 EPS was -$2.30 and the expectation for 2016 is $1.19. I think that is a pretty tall order.

Another way to use the DCF analysis is to calculate a fair value based on some reasonable growth rates and a discount rate. This is what it would look like.

Click to enlarge

Source: Guru Focus

At some point for Tesla to be successful, they will have to transition to more of a manufacturer versus an R&D company. Those types of companies have growth rates that range from 10% to 20% per year for high demand products. Hence, I picked an average growth rate of 15% for the first 10 years and a terminal rate of 8% assuming the company matures. Even a 15% growth rate would be difficult to sustain over a 10-year period. Using those values and a discount rate of 8%, we expect Tesla's fair value to be on the order of $36 per share.

The numbers are clearly approximate but the gap between an estimated fair value for Tesla and its current share price is very wide - nearly a factor of 7. Looks like a decent candidate for shorting to me.

2016 Sales Expectations vs Reality

Tesla says that it will deliver between 80,000 and 90,000 Model S/X cars in 2016 with roughly half of those being delivered in the US. Below is a slide from the Tesla 4Q2015 financial presentation.

Click to enlarge

Note that the chart above is cumulative sales so the number of new sales for 2016 is reflected in the gray and hashed portion of the last column.

If Tesla is going to make and deliver 40,000 to 45,000 Model S/X cars in the US, they are going to have to have some significant acceleration in production, sales and delivery. For the first two months of 2016, Tesla has sold only 3,170 cars in the US. Granted, Tesla has plans to ramp up sales, production and deliveries in 2016 but 3,170 over two months only averages out to 19,000 cars for the year. I can't find data on global sales but, based on the US sales, this is not a good start to the year for Tesla.

Will Tesla Experience A Liquidity Squeeze?

Tesla has been burning through cash as if there is no tomorrow. The chart below shows Tesla's burn rate.

Click to enlarge

Tesla is burning through roughly $400M to $500M per quarter. With about $2B in cash at the end of 2015, that gives Tesla about a year before finding themselves in a liquidity squeeze. Tesla has three choices other than hitting the liquidity wall. Tesla must start making some serious headway on earnings in 2016, goes further into debt, or raises capital via additional equity. I don't see any other practical choices. Tesla has a B- credit rating from S&P - in other words, "junk." Debt would be costly for Tesla in 2016 given the tightening up of the credit markets. Since I don't see Tesla making a lot of headway on earnings in 2016, my bet is on an equity raise in 2016 before the cash runs outs.

Conclusion

I'm definitely in the camp that Tesla is a candidate for a short position. The one sticky issue with a Tesla short position is timing. Tesla has a huge following of supporters/believers not only in the product but also in the stock. While I agree Tesla makes a great product, from purely an investment standpoint, the stock is a clinker. Tesla has staying power due to the larger number of supporters of the company. It may take some type of catalyst to knock the wind out of the stock valuation. Something like hitting the liquidity wall or a blowout on 2016 deliveries. At this point, I'm resolved to closely watching Tesla for signs of a potential catalyst event and the opportunity to short the stock with some confidence in the timing of a valuation correction. I'd also really like to hear other SA reader's opinions on how best to capitalize on this Tesla short opportunity.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in TSLA over 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.