Dimitrios Kambouris
Tesla (NASDAQ:TSLA) is one of the toughest stocks out there to analyze. On the one hand, it has strong historical growth and a dominant position in its market. On the other hand, it is very expensive (going by valuation multiples) and its founder is constantly getting in trouble for his provocative statements. In some cases, Musk has faced legal consequences for things he has said; for example, he once had to pay a $20 million fine for claiming that he had secured funding to take Tesla private.
This time around, Twitter is what’s getting people worried about their Tesla stock holdings. Elon Musk’s acquisition of Twitter was controversial in itself, now Elon musk is raising eyebrows for his posts on the platform. It would be hard to directly quote Musk’s recent posts without running afoul of Seeking Alpha’s political comment guidelines, so I will simply leave links to them off-platform here and here. Suffice it to say, the comments made some people very, very upset.
Shortly after Elon posted his two notorious Tweets, Tesla stock fell 6.3% in a single trading day. There was little material news about TSLA on the day that crash happened; the most recent big story was a bullish one about a surge in deliveries from Tesla Shanghai. Most likely, Musk’s tweets caused the selloff. Given the lack of other negative news, it’s the default assumption.
For me personally, nothing Musk is doing makes Tesla an “avoid at any price” stock. Tesla has great brand recognition, strong growth, and just recently got its tax credits back. The stock has a lot of things going for it. However, Musk’s risk taking is a serious enough concern for me to demand some kind of discount.
In past articles, I got fair value estimates for Tesla well above the current stock price. However, I never rated the stock any higher than a hold; in one article I rated it a sell. The reason for that is the immense uncertainty that Tesla is subject to. Whether it’s Musk’s Tweets or the federal investigation of the Twitter deal, there are many risk factors, some of which could impede the growth that makes the stock appear to have such a great future. For this reason, I’d want to see a price of $75 or lower before I’d buy the stock, even though I get value estimates above $200 when I value it by conventional means.
My Past Coverage of Tesla
In past articles, I’ve usually found Tesla to be worth something like $200-$300, going by a combination of multiples and discounted cash flows. In some cases, those prices were above the market price, but I never gave the stock a ‘buy’ rating, because I felt there were too many risks to the growth story. Some examples of valuations I arrived at include:
$338 in “Tesla: the $4 Trillion Price Target is a Red Flag.”
$879 ($293 in post-split terms) in “Tesla: the EV Tax Credit is a Huge Catalyst.”
A sell rating (no specific price target) in “Long BYD, Short Tesla: a Great Tactical Pair Trade.”
Now, you might wonder why I keep rating Tesla ‘hold’ or ‘sell’ when my models always give it upside. The reason has to do with how discounted cash flow models are constructed. You have to estimate future cash flows in order to make the math work, there’s no way around it. Tesla’s historical growth is extremely strong, and even if you cut the future growth estimates to half or a third of the actual historical growth, you still end up with pretty high price targets. In some of my previous articles, I cut Tesla’s future growth estimate down to the projected growth in the EV industry, which is a lot slower than Tesla’s actual growth rate. It still resulted in upside.
Still, I can’t rate the stock a buy, because I do think the risks here are serious enough to potentially end Tesla’s growth streak.
The first is demographics. Musk’s recent Twitter posts haven’t been received well by the demographics that tend to buy electric cars. Recently, Musk appeared on stage at a Dave Chapelle performance in San Francisco–the city with the second highest number of EV chargers in the U.S.--and was ‘booed’ by some audience members. This evidence might seem anecdotal, but it is known that Musk has low approval ratings in EV-friendly states like Oregon. Combining hard data with news reports, one gets the sense that Elon Musk isn’t being received well in States that are pushing green energy.
EV ownership in the U.S. skews toward affluent, educated, progressive-leaning individuals. Tesla has more conservative customers than other EV companies do, but it still has more democrat than republican owners. Many commentators believe that Musk’s recent Twitter posts have been designed to court conservative support. It is known that Musk is popular among conservatives, and he seems to be trying to shore up that support, but the problem is that Tesla’s customers come from other groups.
It’s not clear that Musk has angered enough people to get large numbers of them abandoning Tesla. A few people have said that they would buy Chevy Bolts in retaliation for Musk’s Twitter posts, but sales forecasts suggest there aren’t that many of them. By all accounts, Tesla’s sales are growing, not declining. Still, there is a possibility of Elon Musk alienating his core customer base; if he does so, we’d expect Tesla’s sales to take a hit.
There’s no shortage of companies selling electric cars. We’ve got European companies like Volkswagen (OTCPK:VWAGY), American companies like General Motors (GM) and Chinese companies like NIO (NIO) building EVs now. If the people who are upset about Musk’s job at Twitter wanted to ditch Tesla, they could do so. So a loss of sales is in principle a potential risk factor.
There’s also Musk’s selling of Twitter stock. As a long-term value investor, this does not really count as a risk to me, but it is a risk to those taking short term positions. Musk had to sell Tesla stock to put up collateral for the Twitter loans. He has sold at least $16.4 billion worth of TSLA, or 3.15% of the float. Insider selling of that magnitude can push a stock’s price downward, as stock prices are a function of supply and demand. If you don’t own Tesla stock now, and want to take a long-term position in the future, this is only good news, but for somebody who already owns Tesla stock, with no plans to average down, it’s very bad. If you already own Tesla and are hoping to get back to purchase prices well above $200, you might be waiting a while. Musk is rattling investor confidence and he may have more sales planned. If you don’t own Tesla stock, or own a little and plan on averaging down, then read on, because in the next section I explain why Tesla stock would be genuinely interesting at $75.
Why Tesla Would Be Interesting at $75
In previous sections, I explained why Tesla, with moderate growth assumptions, appeared to be worth $200 or more. In a DCF model it only takes about 20% growth in free cash flow for TSLA to come out with a fair value estimate well above $200. However, two things have to be kept in mind:
Interest rates are rising.
There are genuine risks to Tesla’s operating performance.
Interest rates going up takes a bite out of the value of cash flows from any company, and Elon Musk’s political commentary puts Tesla’s U.S. revenue at risk. So, a new Tesla model is needed to account for the risks. In past models, I discounted TSLA stock at just 8%. That’s a discount rate that includes a risk premium, but not a very large one. Today, Tesla is in the political crosshairs to an extent not seen when I wrote my last Tesla article, so more risk needs to be accounted for.
There are two ways to do this:
Simply run one of my previous models at a far higher discount rate.
Lower the growth assumption.
The first method is pretty straightforward. If you take my previous model that got a $338 FV estimate, and up the discount rate to 15%, you get a $111 price target. I think buying Tesla at that level would be basically sensible, but it helps to go even stricter still. Remember: when you buy TSLA shares, you’re paying for a lot of future growth. The nature of a ‘financial risk’ is that it can cause growth to disappear, and profits to turn into losses, so we need to account for those scenarios.
I do not think we need to model for a scenario where Tesla’s growth becomes negative. Tesla sells a lot of cars in China, a country that is not plugged into U.S. social media discourse, and where Elon Musk’s private behavior probably isn’t a concern for very many people. The U.S. market position does seem to be at risk, so we can model for a scenario where growth declines to 0%, based on current trends continuing in China while U.S. sales decline. Note that I don’t think this scenario will actually occur, it just helps to model worst case scenarios.
Under zero growth assumptions, we can simply value TSLA in terms of terminal value. This is where you discount free cash flow at a chosen discount rate. The range we get for Tesla, using 3.5% (no risk premium) and 15% (extremely large risk premium) is shown below.
FCF | Value at 3.5% DR | Value at 15% |
2.87 | $82 | $19.33 |
So, to sum up, our total range of values under, when we account for immense risk, goes from:
$19.33 (high discount rate, no growth).
$111 (high discount rate, high growth).
The mean of the high and low values is $65. If you want to be extremely conservative, aim for $65 before buying Tesla. Personally, I’d probably buy at $75, because the worst-case scenarios I’m modelling for here are rather extreme. Most likely Tesla will do better than 0% growth. But in an environment of rising rates, it pays to play it safe. For the most risk averse investors, Tesla does not appear to be a buy.
