With no apparent new fundamental information, shares of Tesla Inc. (NASADQ: TSLA) have soared another 20% after last earnings call. Tesla's CEO Elon Musk recently tweeted about shorts, "These guys want us to die so bad they can taste it;" and "Just wish they would stop sticking pins in voodoo dolls of me. That hurts, ok?" At this point, it seems futile to justify why TSLA is currently sitting at a record high of $380. But, before rushing to blame the market for being irrational or "Tesla has created its own bubble," we are here to make some sense out of the "TSLA Puzzle."
Call Option on Elon Musk's Vision
But Scott Kimball (co-author) at Taplin, Canida & Habacht has hit the nail on the head, "That's why I look at this as an option on Elon Musk. If he gets it right, and he can deliver a power storage option that renders the power grid nothing more than a reserve/backup, the "breakeven" period for installing solar panel drops by an incredible amount. I don't know what that's worth in current dollars, but it's likely a lot more than $350 a share currently. I can't prove it and it's a long ways away from happening."
It may be fun to quantify how much Tesla's loyal shareholders are willing to pay for Elon Musk's vision beyond what has been deemed deliverable. Loyalty, "faithful adherence to a leader," may be measured by the difference between Musk's forecast and the street's forecast. The reason why any option has a value is due to disagreement about the future. For Tesla's case, Musk's forecast is often different from that of the analyst community. If shareholders have more trust in Musk's forecast over the street's estimate, they will be willing to pay up for the difference in forecast futures. Since Musk's long-term guidance is always higher than analyst forecasts, Musk's call option has a positive value. In other words, loyal Musk followers will pay extra for Musk's vision.
So, it stands to reason that Tesla shareholders are willing to pay first the fair value based on analyst forecasted fundamentals and an extra call option based on Musk's difference over analyst estimates.
If they always agree, there is no value on the call option. The call can never be negative. If Tesla shareholders lose confidence in Musk's words, the worst case is they fall back to the street's estimate and don't assign the extra value. In short, in a real world setting, the actual share price, P, can be demonstrated as follows:
P = Fair value + Call option + Mispricing (1)
Fair value is determined by the actual company's fundamentals. The mispricing is the unexplained portion. This approach is unique in many ways. First, an option is usually a separate instrument from the underlying asset, the stock in this case. Musk's call option is actually embedded in the Tesla stock. Second, for the first time, we can assign a numerical value that investors "willingly" pay for their trust in the founder's vision. Finally, such seemingly rational value can be separated from the typical irrational mispricing, the difference between stock price and its fundamentally determined fair value. Since the positive call value exists solely on the difference in forecasts of the future, let's talk about such a difference. As shown by in Table 1, the discrepancy between Tesla's guidance and actual outcome has been consistently prevalent. This justifies the value creation of the call option. For Equation (1), while it is standard procedure to estimate TSLA's fair value, it will take some imagination to price Musk's call option.
Long-Term Call Option Premium
We can look at the call option as "the bet" on Musk's vision to come to fruition. Talking about Musk's vision, Musk's new "master plan" unveiled in Tesla's 2017 Annual Shareholder Meeting includes (1) building a new plant to make the Model Y crossover from a completely new platform, (2) an electric semi truck, (3) thousands more company-owned stores and service centers, (4) a vastly larger Supercharger network, (5) 10 to 20 Gigafactories, and (6) making 5,000 vehicles a week by the end of 2017.
In order to estimate the value of the call, we use the Black and Scholes Option Model which has been known for its accuracy. Under this context, the call option premium can be calculated by the present value of the expected difference between the actual value and the expected value. Musk's call option is a result of the difference between Musk's sales forecast and market consensus forecast (Bloomberg). The option exercise price is set to be the consensus estimate of 2020's revenue, $33 billion ($184 per share). The underlying asset price is Tesla's 2020 revenue guidance ranging from $35 billion ($200 per share) to $40 billion ($212 per share). This is estimated by Musk's claim that Tesla will make 5,000 vehicles a week from 4Q 2017 on, up from 2084 units 1Q 2017. As the volatility of the underlying asset price, or "std," is the key determinant of option premium, it is set to range between 4% and 6%, estimated by the surprise of the actual and guided revenue. Another unconventional aspect of the call is its long-term time to maturity. Since the word "vision" implies a long time and most estimates go up to 2020, the expiration of the call option is set to 3.5 years from now. In Table 2, the baseline parameter values used in the BS Model are summarized.
Musk's Call Premium
In Table 3, the "baseline" case suggests that there is an expected $12-$28 call premium in "additional" 2020 revenue per share, per Musk's estimate with the more likely $13-$18. Given a current P/S ratio around 7.2, the revenue premium can be converted to actual price premium. In Table 4, I also summarize the Musk's price premium under likely scenarios. The call option is equivalent to $94 - $130 price premium with a mean estimate of $115.
More importantly, the estimates of the call option and the stock price premium allow us to better understand the "real" TSLA mispricing as specified in Equation (1). Since what we try to do here is to measure the valuation of founders' vision, we take a short cut in estimating the fair value portion by simply drawing the opinion from the street analysts. From Bloomberg's analyst recommendations, the consensus (average) fair values range is around $265. Adding an extra $115 Musk's price premium, the resulting TSLA share at $380 becomes fairly priced (Table 5).
There are many reasons why we did what we did. Since TSLA fundamental price target is "untouchable," we choose to look into a major portion of the price discrepancy. As all investment actions are investor's options to take, we model the excessive price in the context of investment option. All in all, the market has its own way to judge each decision. If analyst forecasts are wrong, the share price reaction should be contained to the surprise. If Musk is wrong, the investor buying in this call option should be eventually eliminated. The difference is that the analysts are only judged once a quarter by the earnings report, but Tesla shareholder loyalty has lasted more than seven years and maybe many more years to come. Regardless, the remaining mispricing should always correct itself quickly.
The bottom line is that there is $100-$135 of a call premium already embedded in the $380 TSLA price. If you "buy into" the existence of Elon Musk's loyalty option, TSLA is currently fairly priced.
Elon Musk tweeted Wednesday afternoon, "In discussions with the government of India requesting temporary relief on import penalties/restrictions until a local factory is built." Shares of Tesla closed higher by 1.25%.
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.