Why Tesla Is Grossly Overvalued, Even If Everything Goes Terrifically

| About: Tesla Motors (TSLA)

I recently wrote an article for Seeking Alpha explaining why-- based on Tesla's (NASDAQ:TSLA) own public filings-- I don't think the company will ever be able to build a profitable electric car that can compete in the "near-luxury" segment dominated by BMW's 3-series. (Tesla calls this its "third-generation" or "Gen 3" car.) In the comments section under that article, however, Tesla shareholders expressed such vehement doubt about this thesis that I was inspired to conduct a brief analysis of what the company might be worth if everything goes right for it...

BMW, which is generally considered to set the "profitability gold standard" among publicly traded automakers, enjoys roughly19% gross margins, operating margins of around 10%, and a current enterprise value (EV) of approximately 1.3x revenue. (By way of comparison, Daimler AG-- the parent company of Mercedes-Benz-- enjoys better than 20% gross margins but has operating margins that are several percent lower than BMW's and is thus awarded an enterprise value of only around 1x revenue.)

Interestingly, as Tesla's CEO Elon Musk claims that his company's high-end cars will generate 25% gross margins (excluding the sale of PEV tax credits) while its Gen 3 cars will target 15% gross margins, BMW's overall gross margin of 19% would seem to make it a particularly good comparable for Tesla. Thus, let's use BMW's revenue multiple as a valuation metric for "a successful Tesla" and assume that Tesla actually does succeed in creating a third-generation car to compete in the "near luxury" segment...

Let's say that in 2018 (Tesla plans to introduce its Gen 3 model by early 2017) Tesla sells 80,000 high-end vehicles (Model S and Model X combined) at an average price of $85,000 and 200,000 Gen 3 cars at an average price of $45,000 (with revenue thus totaling $15.8 billion) and manages to generate very fat BMW-like gross & operating margins and thus gets that BMW-like valuation of 1.3x revenue. In this scenario, five years from now the company would be worth $15.8 billion x 1.3 = $18.6 billion. (We will very generously assume that Tesla will have no debt and will thus be able to finance its production capacity expansion-- which I estimate would cost well north of $2 billion-- entirely from cash flow.)

If we then take this $18.6 billion EV and discount it back by 15%/year (although I doubt that anyone is currently holding Tesla @ $129/share for a "mere" 15% annual return), we'd have a net present value for the company of approximately $9.2 billion. If we then divide $9.2 billion by 126 million fully-diluted shares (including options and making the extremely unlikely assumption that there will be no additional share issuance between now and 2018), we get a net present value for the stock of $73/share, which is 43% lower than its recent closing price of approximately $129/share.

Perhaps, however, I'm being too conservative regarding Tesla's future prospects and should instead assume that the company will be able to generate BMW-like margins while selling 80,000 vehicles a year at $85,000 and 400,000 Gen 3 cars at $45,000. In that case, using the same metrics as above; i.e. 1.3x 2018 revenue, a 15% discount rate and the generous assumption that Tesla will be able to fund entirely out of internal cash flow what I estimate would be over $3 billion of additional cap-ex, the stock would currently be worth... $98/share.

Thus, despite a risk-adjusted supposition that everything will go terrifically well for Tesla over the next five years, its stock is still currently overvalued by at least 24%. On the other hand, if things start to go wrong...

That's why I think a short position in Tesla at its current price is like owning a non-expiring put option with an extremely low (currently less than 1%/year for the "borrow") cost of carry.

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.

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