Tesla: What's It Really Worth, Part Deux

| About: Tesla, Inc. (TSLA)

Summary

Musk's big reveal left many unsurprised as his vision for an integrated "green" company seemed obvious.

The SolarCity deal still stinks: it's one of the worst examples of corporate governance ever.

Using Musk's $1 trillion valuation, and a 10% chance of that being realized in 15 to 20 years, I assign a $145 valuation to Tesla.

Some time ago I outlined what I thought Tesla as a car and battery brand was worth ($100 per share). Since then we've had a few major developments in the Tesla story, and I thought I'd share my thoughts on them.

SolarCity

A company with hugely negative cash flow and over $3 billion in debt in a highly competitive, capital intensive industry acquires another hugely cash flow negative company which is in a completely separate industry. Oh and the CEO and largest shareholder of the first company also owns a big stake in the second, which is run by his cousin. Does this make sense to you?

It doesn't really to me either. I could see Musk's vision of an integrated energy company as soon as the deal was announced, but what I couldn't see was where that made sense financially. Musk wants to pair powerwalls with SolarCity panels; great. Except that both of these are horrendous businesses from a financial point of view! Tesla has no competitive advantage in batteries, and no competitive advantage in solar panels either, so aside from the fact they're offering integrated products first, I don't see what they have.

Now, lets say that it all works out, and the fact Musk is a first mover in a combined battery/panel offering gives him big market share. What are the returns on that sort of business? Duracell had EBITDA margins of maybe 20%, and EBIT margins of maybe 12%, which is a little better than the automotive segment. Recall that Duracell owns about 25% of global market share for batteries, and gets immense scale benefits from that position. The battery business is generally a little less capital intensive than cars, so the returns on capital are slightly better, but not that great.

The relevant question is what market share can Tesla get? I don't think anyone knows, but they are pricing their product and marketing it to appeal to an upper end segment of the market. I think this limits their mass appeal, and it therefore means their market is significantly smaller than Duracell's, and becuase of that Tesla isn't going to be able to get the same sorts of scale. I think even if the battery business is mature, returns aren't going to be high.

Similarly, because Tesla has no IP, no competitive advantages other than marketing and vision with regards to their battery offerings, I don't see why this business should garner a high multiple.

Master Plan Part Deux

I wasn't surprised by what Musk laid out for this. I think it's a great vision for Tesla and of the future. What's different is I have no clue how Musk or ANYONE can get it done within the confines of a single company.

Musk has a history of building great things, but they've been small. Paypal was a very capital light business, so all you had to do was code and market. SpaceX is much more capital intensive, but it serves a very narrow market and has a very clear vision: they're not trying to do everything.

Tesla is a different story. They're trying to do everything, and become a Mercedes or BMW in so short a time that they're messing up. They're missing earnings, they're spending WAY more on capex than they promised, they're facing delays, their SUV isn't selling well. The list goes on and on of how Musk's vision for Tesla hasn't panned out the way he said. How can they add a bus, and a pickup if they can barely make 1 car and 1 SUV without massive manufacturing problems and quality issues?

History tends to repeat: I don't think Musk's vision part deux works out either. It's a great plan and vision, and I could see it playing out over 100 or 150 years, but guess what: things change over time. New technology pops up, wars start, demographics change. 10 years ago, MySpace was dominant and many people thought that would continue. Then Facebook happened. People thought Blackberry would be dominant in smartphones forever, then Apple decided to get in on that game. Now Apple is facing pressures from Google and Samsung.

Musk's plan was so unspecific and so grand, I view it as unlikely to happen simply because there is such a high risk of competitors copying his ideas, or unforeseen things getting in the way. Remember, Musk doesn't have a monopoly on genius: there are many other people trying to do exactly the same thing as him, and many of them work at much larger companies with more resources.

Financing

What really gets me is the massive financing Tesla will require. What Musk plans can't be done on internal free cash flow. They're going to need to raise debt and raise equity, and they're going to have to do it frequently and in larger amounts than anyone can imagine.

Maybe he can do it, but I don't think so. Musk says this will all propel Tesla to a $1 trillion valuation, but it'll be an expansion dependent entirely on the capital markets. Apple almost got to $1 trillion on INTERNAL cash flows alone, which is a far better model.

For an example of what happens when you try and expand too fast into highly capital intensive, complex businesses and rely solely on the capital markets for it, look at Sunedison. It made 1 misstep in the acquisition of Vivint Solar, and that imploded the company. Tesla runs the same risk because they're reliant on investor sentiment to keep cash coming in the door.

Valuation

My original valuation for Tesla was $100 per share. I like Musk's vision, but I don't know how he's going to do it, and I see huge risks to it happening. For that reason, I put a low probability of Tesla succeeding in all it's goals.

But forget that. Let's do some math! The way to think about Tesla is like an option. We have a car business, and we know what that's worth roughly. But what about the option for all the other stuff? For simplicity's sake I'm going to use Musk's own $1 trillion valuation, and I'm going to say it's going to take a while for that to happen. I'll use a 12% discount rate to discount the future back. The results are below.

It's hard to know exactly what the market is pricing in, but I think Musk's vision takes 15-20 years to pan out, so anything in that 10 year column isn't reasonable.

I also think that there is limited possibility that Musk achieves all he wants, and there is less than a 50% chance that Tesla gets to $1 trillion. Using a 25% probability that Tesla achieves $1 trillion in 15 to 20 years, then shares should trade between $177 and $313, which is basically where they're trading now. So where's the upside (I ask again...)

But here's the rub: the $1 trillion figure is a valuation figure, and is therefore wildly subjective. GM trades at an EV/Sales of about 0.65x, so Musk would need to get sales to almost $2 TRILLION to get his valuation if that's how Tesla is valued (and why should a company with no competitive advantage except scale, in a line of 10-12% EBIT margin businesses be valued at any wild multiple?).

Even at 1x sales, Tesla would have to get to be double the size of Wal Mart, or 4x the size of Volkswagen in 15 to 20 years. Its a tall order no matter how you slice and dice it. And to do this without error, in a shorter time than anyone on earth has done it? I just have a lot of trouble placing a high probability on that. Nowhere in human history has a single private entity with the limited resources that being private necessarily places on a company, done this, and it hasn't been done for good reason: it's exceedingly difficult.

The example of something of this magnitude being done that I can most readily think of is the space race. NASA got a man on the moon in remarkably short time, but they had access to over $43 billion PER YEAR in 2014 dollars to get this done, and those dollars weren't given to NASA on the promise that they earn a return. How can Tesla accomplish something of effectively the same scale, while being constrained by the fact that at some point, they're going to have to earn money.

Conclusions

Steve Jobs almost built a $1 trillion company, but he did it with high margin products and had a huge advantage on the market, and he had a very limited vision (compared to Musk). I believe this is the way to build a company: vision, yes, but one that is focused, targeted, and one that aims to be dominant in one thing at a time, not all things at once.

Musk's vision is great, but I believe it would be more likely if many companies worked towards it, not just Tesla simply because Tesla will have such trouble getting the resources it needs to accomplish what Musk wants. If he keeps setting up companies like SolarCity which make huge cash losses, and simply absorbs them one by one into Tesla, eventually Tesla will fail. I think Musk is smarter than that of course, but the simple fact is that he is limited financially.

Because of that, I place very limited probability of his vision being achieved, and a $1 trillion value resulting for Tesla. The current car company I value at $100 per share, and if you add to that the option value of a successful vision at a 10% probability, that brings my valuation up to $145 per share, still woefully short of where the company trades.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.