When analysts write about Tesla (NASDAQ:TSLA) they do so from the viewpoint that Tesla is the early and clear leader in the EV revolution. They then proceed to model a future which is akin to a clear success for Tesla. A future including 500k units being sold by 2020. But what if other outcomes are possible?
To answer that question, I am going to explore what Tesla might have in common with Commodore International. As we will see, it turns out it is a lot. And that's not comforting.
So to start, what does Tesla have in common with Commodore International?
As a quick brief, Commodore International was an early leader in the PC revolution, namely with its famous Commodore 64 computer.
Commodore International could be said to have a lot in common with Tesla, for instance:
- Both were early leaders in their industries;
- Both of the industries they were in were high growth and destined to change the world;
- Both achieved a high market share in their prime, and held it for at least a few years;
- Both had their stocks fly up because of these two realities;
- Both eventually faced significant competition in their markets.
What did Tesla not share with Commodore International? Basically, Commodore International turned very profitable while leading its market. Tesla did not.
This reminds us of a very basic reality: history is littered with early leaders which ultimately didn't win. Even early leaders that turned profitable quickly, achieved great market share in strongly growing markets and ultimately didn't win. Commodore International was one of them.
But let's see in a bit more detail how things went with Commodore, and why it eventually faltered.
How Commodore International went (Source: FundingUniverse.com)
Commodore International was first born as Commodore Portable Typewriter back in 1958. It was founded by Jack Tramiel.
Its claim to fame, though, would come many years later, when it for a while dominated the emerging home computer scene from 1980 to 1984, with the successive launches of the Vic 20 home computer, and then the famous Commodore 64 home computer.
These home computers were so successful that Commodore's stock went from $5 ½ to $138 ¼ in just 2 years. Its revenues and profits also exploded, from as little as $50.1 million in revenues and $3.4 million in net profits in 1978, to as much as $1.27 billion in revenues and $143 million in net profits in 1984.
Thus, for a long period Commodore was an incredible home computing leader (in Europe, not so much in the U.S.) growing at incredible rates, both in share price and in revenues and profits. Furthermore, it had a measure of barriers to entry, since it controlled the design of some proprietary chips in its own computers, through its MOS subsidiary.
The following chart shows how the share of the market in home computers evolved, over these years (Source: Asymco.com):
The Commodore 64 ultimately outpaced even the IBM PC (launched in August 1981, versus the Commodore 64 January 1982 launch date), and it enabled Commodore International to have a peak market share of around 40%. Yet, after 5 bountiful years, Commodore ultimately failed.
Why did Commodore International fail?
Ultimately, it failed because market leaders are usually not pre-ordained. Two factors can always make a market leader falter. They are:
- The lack of barriers to entry in the industry. If there are no barriers to entry and the industry is somehow seen as attractive (due to profitability or high growth), then competition will come. There were no barriers to entry into the home computer/personal computer market. Many competitors entered this market, and the products from each one fought on level ground. When such a thing happens, the likelihood of any of those competitors winning drops dramatically;
- The lack of sustainable advantages. If a leader does not have some kind of intrinsic advantage over its competitors, then when competition comes anyone can win. Most of the sustainable advantages come from things like powerful patents, strong brands, network effects, natural monopolies and intrinsically lower costs. Commodore had neither of these to rely upon - it had to fight the incoming competition on level ground.
If there are no differentiating factors and no barriers to entry any competitor can win. The more competitors you have, the lower the likelihood of any of them winning. And this goes even for former leaders with 40% of the market, massive revenues and significant profits, like Commodore at the time. Just for us to have an idea, by 1984 Microsoft (NASDAQ:MSFT) - a company founded 9 years earlier - had revenues of just under $100 million, or less than 1/10 what Commodore was pulling in (Source: thocp.net).
So what do you do when discounting the future of a company that's a clear leader, growing quickly and highly profitable? You need to look into the market structure, and ask yourself … is there a barrier to entry? Is the playing ground level? Are there sustainable advantages for any player?
For Commodore, there were no barriers to entry and no sustainable advantages. The market was a level playing ground. For Microsoft it was different - as the PC dominated the market by being built by tens of different manufacturers, if you wanted to have a PC, you needed to have Microsoft DOS - it had a natural monopoly, which in time was reinforced by network effects. Likewise for Intel. Not only were there barriers to entry and sustainable advantages, but they were for the most part insurmountable.
Why can Tesla be similar to Commodore International?
Tesla falls under the exact same rules, except for the fact that it isn't that profitable right now, while it faces no similar EV competition. Yes, Tesla is presently dominant at the high end of the EV market. But no, that dominance is not assured for the future.
As I've explained, the Model S P85D guaranteed cars from high end makers would be built to the same tradeoff as that taken by Tesla. This was confirmed soon after by Audi (OTCPK:AUDVF) and others. This means those cars will come with similar large batteries, and similar long range, and similar performance. Those will be cars made by Audi, BMW (BAMXY), Mercedes and perhaps a few sports car makers like Porsche (OTCPK:POAHY) and others.
There is nothing Tesla can do to avoid these cars from hitting the market. It will take a few years for it to happen as the models are being designed right now, but that's all Tesla has - 3 years at most, before equivalent competition hits the market from several established car makers. Car makers which today are able to produce higher quality cars than Tesla, with better interiors and more efficiently produced (meaning, taking less hours and less materials to build). There are thus no barriers to entry.
Even if Tesla catches up on the quality, interiors and efficiency, in 3 years' time it will still face cars that are in every regard a match to its own product. By then, every model will fight it out on its own merits. And only faith can make someone believe that there's any intrinsic reason why Tesla would be the pre-ordained winner of that fight. Tesla thus holds no sustainable advantages.
Tesla is not sure to lose, either. But it can. And the more competitors it faces, the greater the likelihood that it will, indeed, lose. Like Commodore International ultimately lost.
When valuing Tesla, this has to be taken into account - not only do you need to have a "success scenario" like in most of today's published research, but there needs to be a probability associated with it.
If the playing ground is level, no competitor has much of an added likelihood of winning, and for Tesla losing probably means bankruptcy (as it meant for Commodore International, which was better positioned and more profitable than Tesla is now). So even if you think Tesla is worth $1000 per share in the case of success, if the success scenario has only a 20% chance of happening, then the shares would be worth just $200. And that's if you believe in $1000… because most success scenarios struggle to justify $250 per share right now, even with 100% likelihood given to the success scenario.
Can market growth save Tesla if it loses?
In the comment sections of previous articles, when faced with this logic, some bullish commenters respond that EVs will be growing so much that it doesn't matter. The Commodore example again puts this notion to rest - the PC market grew astoundingly - and that still didn't save the losers (Source: Asymco.com - same URL as before).
This is so because most companies taking part in a high growth market (and particularly the early leaders) size their investments to seize the opportunity. If the opportunity then goes to a new leader, those investments become the death knell for the losers.
So if Tesla loses, particularly given its gigafactory investment but not just because of it, overall EV market growth most probably cannot save it. What happened in the PC market and in countless other growth markets shows as much.
Being an early leader in a growth market is no guarantee of success. Either the leader possesses sustainable advantages over any new entrant, or his leadership (and indeed, survival) will always be at risk.
This is the situation Tesla finds itself in. It is an early leader in the high end EV market. Not a particularly profitable one, but it still leads and its share price discounts great enthusiasm regarding its future.
Yet, Tesla has no sustainable advantage to its name. We know comparable competition is coming. There are no barriers to entry, so the final winners are still to be decided even though Tesla started early and built a commanding lead.
The Commodore International history - a company which reached great heights in revenues, profits and market share in a massively growing market - shows as much. It, too, had no sustainable advantage. So when competition came, its ultimate likelihood of winning was not that much greater than anyone else's. And indeed, it didn't win. By 1994, Commodore International went bankrupt.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.