Tesla's Matrix Moment

| About: Tesla, Inc. (TSLA)


In The Matrix, there is a moment towards the end of the movie where the main character, Neo, gets shot and apparently dies, only to revive, cheating death and opening the possibility of a complete paradigm shift for that world. Tesla (NASDAQ:TSLA) is at a similar point in its own story. At the beginning of April, the company said it has now sold over 4,750 of its Model S cars and will announce its first ever quarterly profit on May 8, after the closing bell. The company that many said would fail (42% of shares held short as of April 15) may be poised to usher in a new era of emission-less vehicles. As a result, Tesla shares are hitting all-time highs.

TSLA Chart

Stock markets can be a lot like the Matrix. Both have rules, but as Morpheus explains in the movie, "Some of them can be bent. Others can be broken." Tesla is a rule-breaker if ever there was one. The ratio of share price to earnings (be it revenue, free cash flow, or net profit) is an example of a rule that is often flouted. As in the Matrix, belief is an important factor when rules are violated. A stock can be very far off the established ratio for its business type so long as investors believe that earnings will one day catch up and bring the math back in line. For Tesla, this means it will eventually have to grow its business to more than 25 times its current size simply to justify today's price, as shown by the table below.

Ford (NYSE:F) GM (NYSE:GM) Toyota (NYSE:TM) Honda (NYSE:HMC) Tesla multiple to peer average
Price/Earnings 9.636 8.208 18.940 16.230 458.333* 35
Price/Sales 0.4086 0.3356 0.6710 0.6208 14.2900 28
Price/Book 3.362 1.612 1.405 1.340 50.540 26

* - projected P/E based on analyst average .03/share profit and $55 share price

The Scene

In light of this, it makes sense to focus on the long-term prospects. The company story first surfaced in 2006, when Elon Musk's "day job" was running SpaceX. In many ways, Tesla's goal is just as visionary: "the overarching purpose of Tesla Motors ... is to help expedite the move from a mine-and-burn hydrocarbon economy towards a solar electric economy." When this purpose was first stated, peak oil concerns were, well... peaking, and gas prices were at all time highs.

Since then, however, gas prices have remained fairly flat in inflation-adjusted terms, and use of imported fuels has recently fallen even as production has risen. At the same time, the solar industry has crashed, which is probably a factor in Tesla's plan to offer free solar-powered supercharging stations. Nine have been implemented so far, and they take an hour to provide a full charge (300 miles at 55mph with temperate weather conditions). When you consider the implications of this, it begins to become clear that sustained success for Tesla depends on continued technological development and significant expenditures for expanding infrastructure.

As with any good movie, problems arise as the plot proceeds. One of the causes underlying the solar crash is the inability of current electrical grids to handle renewable energy sources. Existing power grids are simply not built to transmit the variable power levels supplied by renewable energy sources. Storage of intermittent supply is an even bigger problem, and one that is shared by electric cars as well as power grids. Even top notch batteries like Model S's can become permanently inoperable if left for extended periods and lose charge even when not used. Thus it's clear that recharging costs exceed actual mileage driven. When you consider this together with the inefficiency of power generation and grid leakage, such costs could only increase if electric vehicles were to replace hydrocarbons at the scale required by Tesla. In any case, that scenario is suspenseful, to say the least...

The Adversaries

Cue our villains, and what better ones than oil companies? The rising production and falling importation of oil, referenced above is the result of new drilling methods and fuel sources. The alternative fuels currently seeing increasing use include natural gas and propane. All of these burn cleaner than gasoline and already have larger vehicle footprints than Tesla. None of them have the energy-loss problems associated with batteries and power grids.

First up is natural gas. In the States, it is cheap and abundant. This special report from The Economist gives a great overview and says,

Only half a decade ago it looked as though the world might have only 50 or 60 years worth of gas. Now shale and other unconventional as well as new conventional gas finds have increased that period to 200 years or more.

Most companies with truck fleets, like UPS (NYSE:UPS) and FedEx (NYSE:FDX), are increasingly switching to natural gas. Waste Management (NYSE:WM) is not only converting its entire collection fleet, it also makes many of its refueling stations open to the public.

Propane or "Autogas" is more popular for consumer vehicles outside the U.S., particularly in progressive markets like Turkey, South Korea, Poland, Italy, and Australia. It produces 35% less carbon dioxide than gasoline. In Turkey, over half of passenger vehicles have been converted to use propane and efforts are underway to popularize it in America.

These alternative fuels represent the true competition for Tesla. What makes them so dangerous is that they represent a smooth path, with gradual investment and reuse of existing technology. By contrast, all-electric solutions won't really be fully viable until smart-grids and better battery technology are in place. In a longer-term scenario like that, the fossil versions of these fuels could eventually be shifted to recycled or grown replacements, thus preserving the goal of transportation from completely renewable sources.

The End?

To his credit, our hero seems to secretly recognize that Tesla cars aren't ready for the average consumer yet, and that the company needs to get there sooner rather than later. In Telsa's most recent press conference [sign in required], Elon Musk emphasized that the next car offering would be more affordable. He had also predicted that the current Model S would be priced around $45K instead of the current base of $62K, however. Designed to sell more cars now regardless of the future cost, the bulk of the announcement sought to allay fears about battery replacement with a new warranty and changes to service requirements. After all, those costs are only a concern while the company is still solvent. Even Mr. Musk's comments seem to recognize that current TSLA stock pricing is the result of a short squeeze rather than current fundamentals.

Like The Oracle, "I hate giving good people bad news." Our hero has the right solution, but most likely at the wrong time. Tesla has built an all-electric car about as well as can currently be done, but now the company has introduced profitability into its belief structure for the first time. Will investors continue to believe if future quarters show that accounting and early adoption euphoria had more to do with turning a profit than making a broadly usable car? For sustainable success, further technological advances and large infrastructure investments will be required.

When its story began, it looked liked the Tesla plan might be our best hope. However, in the past five years technology and macroeconomics have conspired to create a scene which looks more like the one Neo faced near the end of the final Matrix installment, as he faced more evolved versions of Agent Smith and realized that his survival was contingent on even greater belief and innovation. While Tesla's vision is truly the best for the very long term, it is probably still multiple generations away. Even if Tesla does eventually survive to see the paradigm shift it has envisioned, it is likely to be after further dilution to current investors, and quite possibly beyond any current investment horizon. As I've written in previous articles, even high-growth investors ignore valuation at their peril. Wall Street may not be reality, but it's not Hollywood either.

Disclosure: I am 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: My short position is small and recently acquired, during the squeeze. Although I may increase my position with further LARGE moves in stock price, I would caution others to be very careful when considering a short position in a story stock like this.