My 'It's Not Rocket Science' Tesla Short

| About: Tesla Motors (TSLA)

Summary

By most metrics, TSLA is extremely overvalued relative to its peers.

Even the most optimistic sales projections for the Model 3 don't justify TSLA's current stock price.

I believe that TSLA and Elon Musk's real achievements, laudable as they are, have blinded the market to the many challenges still facing the company.

I have recently added substantially to my short position in Tesla Motors (NASDAQ:TSLA) because at today's prices, I think it's one of the most overvalued and overhyped stocks in the entire market. In what follows, I'll try to outline my reasoning, which can be broadly divided into three aspects: overvaluation, reasons why the market is mispricing Tesla's equity, and the timing of my short position.

Overvaluation

Let's begin by looking at some key metrics for various automakers (prices as of COB Friday, April 22 and data from Yahoo! for simplicity).

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Due to its small size, TSLA is growing revenues 3X faster than its rivals. But on every other metric except debt to equity, TSLA is valued at many times its peers. To put it another way, TSLA would have to grow its sales by 30 times, and its book value by 26 times in order to justify today's market capitalization. This will be particularly difficult since it's the only company losing money (see its negative P/E) and because it's running at negative operating cash flows.

Of course, say TSLA bulls, the idea is that future Model 3 sales, as evidenced by the 400,000+ current reservations, will more than enable TSLA to grow into its current valuation.

To vet this idea, let's perform a back of the envelope calculation to see what this implies about the future Model 3 sales that are already baked into today's stock price. Assuming that going forward TSLA can sell 50,000 Model S's and 30,000 Model X's annually at ASPs of $97,000 and $115,000 respectively, we get $8.3B in future annual Model S/X sales. Then assume $1B in Powerwall sales. TSLA's market cap is $33.51B, so without any further dilution, TSLA would have to sell $33.51B/0.27 - $9.3B = $114.8B annually in Model 3's.

At an average ASP of $43,000, that requires selling 2.67M Model 3's annually. Even if TSLA trades at 3 times the average P/S of the rest of its peers, it would have to sell 746,000 Model 3's annually simply to justify today's valuation. And of course, TSLA will need to raise huge sums of money to establish this production capability, hence the future share count and market cap will be that much higher and therefore require even larger sales numbers to justify today's stock valuation.

It is therefore safe to say that TSLA sports an enormous premium, even assuming fantastic future growth. So what has given rise to this valuation?

The "It's Not Rocket Science" Attitude

I personally believe that the central explanation is an attitude particularly prevalent among the company's analysts and fanboys (who have more of a role in establishing the company's stock price than TSLA itself does). I call this attitude the "it's not rocket science" mindset. Before explaining it, let me cite the very positive facts, which give it some credence.

The Model S features a plethora of technology and performance aspects that haven't previously been seen in the auto industry. Indeed this is why Consumer Reports initially gave the Model S its best score ever, 99 out of 100. Obviously, TSLA can do things that other car companies can't or at least haven't.

But perhaps even more impressive are Elon Musk's overall accomplishments and capabilities as made clear most recently by his other company, SpaceX (Private:SPACE), landing a Falcon 9 rocket on a drone ship at sea.

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This is a technological marvel, and Elon Musk is rightly celebrated for spearheading the effort. But while I find the achievement inspiring, I don't translate it the way his proponents do, viz. arguing that surely such a man can do anything.

More importantly, it's these proponents who then become dismissive and even contemptuous of more mundane economic and logistical problems. Their retort to any questions about how the company will scale its production, or handle the logistics of worldwide service centers and superchargers, or the details of building the so-called Gigafactory, aren't really answers, they're simple hand-waving to note that such problems aren't "rocket-science" and hence don't really rise to the level of even being concerns.

As a result of this attitude, SpaceX can engineer a marvelous rocket landing at sea - because this is a real problem to be solved - but the Model X is shipped with doors and windows that may or may not open and/or close properly (because dealing with such trivial problems is beneath the intellect of those involved). TSLA has issued somewhat of a mea culpa citing "hubris" in explaining the shortfall in first quarter Model X shipments as follows (my emphasis):

The root causes of the parts shortages were: Tesla's hubris in adding far too much new technology to the Model X in version 1, insufficient supplier capability validation, and Tesla not having broad enough internal capability to manufacture the parts in-house. The parts in question were only half a dozen out of more than 8,000 unique parts, nonetheless missing even one part means a car cannot be delivered. Tesla is addressing all three root causes to ensure that these mistakes are not repeated with the Model 3 launch.

But to my ears at least, this mea culpa doesn't really get to the heart of the problem. For e.g., if any other company were to observe that one has to have all of the parts of a car to actually make the car, it would be lampooned. But when TSLA says it, the fanboys consider it wisdom for the ages.

Similarly, when the Model S came out, any critic who said that scaling up to (the then-expected) 100K annual sales rate would be difficult and expensive was dismissed with the utmost contempt. Having been one such critic, I remember the explanation I was given: The Nummi plant had produced 500,000 cars per year, so scaling was a "no brainer." Simply run 3 shifts and you've tripled production. But what about time for maintenance and tooling adjustments, or getting 3 times the number of parts from suppliers who presumably weren't sitting on 66% unused capacity, etc., etc? The problems weren't rocket science, so the attitude was, they weren't really problems.

Today I'm of the opinion that TSLA was actually both supply and demand constrained for the Model S, and without extra spending for advertising (demand) and production and supply-line improvements (supply) the company will continue to be so.

But back to my thesis, bottom line, the dismissive attitude about the real challenges TSLA faces have given rise to a completely unjustified valuation of the company's stock. Said another way, when the perspective towards competitors' achievements and missteps is simply: the achievements are trivial and the mistakes speak to them being idiots, then most likely the competitive threat is being underestimated. Yet that's how TSLA's proponents almost universally view other automakers.

Timing and Trading

Much of what I've said here has been true for a while, so why add substantially to my short position now? The basic answer is that I think all the positive TSLA news is now out, so that we have a "sell the news" opportunity. Moreover, the most likely future news will include:

  • Continued problems with the roll out of the Model X (including problems with doors, overall fit and finish, long wait times in the service centers, and the concomitant delays in servicing Model S owners' needs).
  • Competitors' unveilings, including but not limited to the Chevy Bolt.
  • Possible drop off in Model S and Model X demand as potential buyers decide to defer purchases until the Model 3 comes out.
  • Beginning of lease vehicle returns and their effect on the resale value of used TSLA Model S's.

Of course, TSLA is an incredibly volatile stock, exhibiting exaggerated moves both up and down on any news event, so even more than normal, I plan to trade from the short side, taking advantage of short-term pops to add to my position and short-term dips to reduce it. I will also hold a small "core" position for the long term to profit from the stock's ultimate and inevitable return to fair valuation.

Disclosure: I am/we are short TSLA.

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: I actively trade around core positions.