Overview
Tesla (NASDAQ:TSLA) has been on a tear in 2020, rising by an incredible 695% despite the global pandemic. While Tesla faced various difficulties in early 2020, including a shutdown of Shanghai Giga and its main factory in Fremont, everything worked out for the electric-manufacturer afterward. The company broke ground in Europe for its first Giga in Berin and joined the S&P 500 by posting its fourth consecutive profitable quarter. The developments favored investors who believed in a turn-around after a bumpy path towards profitability.
On the other hand, short-sellers have lost a staggering $38 billion in 2020, causing short-interest to plunge to less than 6% of Tesla's float. The immense surge in Tesla's share price was accelerated through the following short-squeeze, as short-sellers were forced to cover. However, despite Tesla's turnaround and ability to demonstrate its business model's profitable scalability, various short-sellers still believe in an attractive opportunity for different reasons. In the past, famous short-sellers, including Mark Spiegel, have justified their short positions by stating a fraudulent business model, a bubble-like valuation, and losing market share to competitors. Thus, throughout this article, I aim to counteract the stereotypical short-seller arguments and explain why Tesla may still be an attractive investment opportunity even at current price levels.
#1: 'Losing market share'
-United States
Unsurprisingly, the United States is Tesla's most crucial market in terms of sales. With its largest production factory in Fremont, the U.S accounts for nearly 50% of the company's sales. Considering the total automobile market in the U.S, Tesla's market share hovers around 1.3%, compared to market leader General Motors with a share of roughly 17%. However, looking at the market share of EV's in the U.S, the picture points at massive domination. In the first half of 2020, Tesla held an astonishing share of 81.7%, slightly up from figures recorded in 2019.
It is crucial to point out that BEV sales in North America are expected to grow to over 1 million by 2025, accounting for nearly 7% of total light-vehicle sales. In this context, Tesla continues to dominate the American EV market. Tesla's Model 3 sold nearly five times more than the closest competitor 'Chevy Bolt' and 13 times more than the Nissan LEAF. Moreover, Statista estimated that out of the top five selling BEV's, 4 out of 5 were Tesla Models, with the Chevy Bolt placing fourth on the list. That said, Tesla's market share is expected to drop significantly by 2030, as legacy automakers are ramping up EV production. While the market share could steadily drop towards 20%, overall deliveries should increase fivefold. Either way, 20% market share in an ever-growing market would still be sufficient to ensure a dominant position in the space.
-Norway
Norway is an important country to analyze the market share, as its the most advanced nation in adapting green technology and electric vehicles. In 2020, BEVs already accounted for 54% of all new cars sold and aims to become the first nation to end ICE car sales by 2025. Therefore, it might be a crucial indicator of what market share to expect in other countries when fully adapting BEVs.
Source: Author (Total deliveries/ Total EV market share in percent) *estimates based on sales data from Model 3 and X
As of 2021, the Nissan Leaf is the all-time best-selling fully-electric vehicle in Norway with cumulative sales of 65589, followed by the VW e-Golf (47574 registrations) and the BMW i3 with 28135 sold units. Tesla's Model 3 ranked fourth with 23470 registrations, followed by the Model S with 21097 and the model X, ranking 9th. However, it should be noted that all of Tesla's models combined would be ranked second with a total of 58375, closely behind Nissan. Moreover, the starting prices of the Leaf and VW Golf are significantly cheaper than Tesla's models, yet still place second in cumulative sales. Notice how Tesla's market share quickly picked up in 2019 after the model 3 began shipping to Norway.
Tesla's market share fell sharply to 8.5% in 2020 as the pandemic affected supply chains and production. However, the Model 3 still placed second with 7770 registrations. In 2021, Tesla's market share in Norway should increase again as supply chain and production-related issues fade. Furthermore, if the Gigafactory in Berlin starts production within this year, registrations should surge as well.
-China
The country is the largest manufacturer and buyer of electric vehicles globally, with nearly 1.3 million units sold in 2020. Tesla broke ground in Shanghai in 2019 and delivered its first cars in early 2020. The electric car-manufacturer aims to produce at a rate of 250 thousand cars, as it's ramping Model Y production to full capacity.
Source: Tasmanian (ARK Invest)
While BYD sold the most NEV vehicles overall in 2020, Tesla dominated the BEV space, leading the ranking of most sold plug-in cars throughout the year. The Model 3 sold a staggering 116 thousand times, far ahead of the Wuling HongGuang Mini, which sold roughly 86000 units. That said, ever since its inception in 2020, Tesla captured 15% of China's electric vehicle, growing from just 6% in 2019 to roughly 21% in the first half of 2020. The disruption in market share has been achieved despite intense competition from domestic manufacturers, including Nio (NYSE:NIO), Xpeng (NYSE: XPEV), and BYD.
-Declining market share is normal
Even if so, it's a normal process to lose market share in a new and rapidly growing industry that attracts competitors. While Tesla continues to dominate the global EV market with a market share of 18%, other car manufacturers are increasingly slicing the pie. However, that may not necessarily be a threatening trend for Tesla, considering the entire future market size. In this context, global BEV sales are expected to hit 12 million in 2025 and exceed 21 million by 2030, as countries are increasingly switching to green transport with the cost of electric-powered vehicles declining rapidly. Even if Tesla manages to keep a moderate 10% market share in 2030, it will sell millions of cars in the future. To elaborate, Apple's market share in the smartphone market declined significantly after initially dominating.
Source: Televisory (Statista)
#2: 'Competition is coming'
Perhaps the most prominent bear argument against Tesla is the competitive pressure from traditional car manufacturers, including Volkswagen, BMW, General Motors, etc., which promise to come close to Tesla in terms of performance. Volkswagen announced plans to launch 70 new EV models, producing 22 million EV cars by 2030. Short-seller Mark Spiegel has noted in an interview that Porsche, Daimler, and Jaguar are bringing out models with a longer range and overall higher quality.
Source: Author (Top 10 electric cars by full charge range) (LR=Long Range)
As of 2021, Tesla's models dominate the list of electric cars with the longest range in a single charge. The range of the Model S (long-range) is nearly 100 miles longer than the closest competitor, the Jaguar i-Pace, and some 140 miles more than the second best selling mid-sized BEV 'Renault Zoe'. That said, Tesla's average range is roughly 300 miles, compared to an average range of just 170 miles of a regular U.S EV. While Tesla's batteries are supplied mainly by Panasonic, the company innovates in battery technology, aiming to produce a 1 million mile-lasting battery. Moreover, Tesla also owns the largest fast-charging network of any EV company with over 20,000 chargers worldwide and continues to expand the network, most notably in China.
However, the main competitive advantage is derived from its integrated cutting-edge software, allowing for autonomous data collection. In terms of autonomous driving, Tesla is years ahead of competitors and aims to reach full autonomy in 2021. The FSD 3.0 hardware chip makes it possible, which accelerates the neural network for autonomous capabilities. Competitors, including Ford and GM, are yet to catch up with Tesla's autonomous software. According to a report, Tesla will realize billions in potential software revenue in 2022.
It's also worth mentioning that CEO Musk has built a compelling brand around himself: Tesla's brand perception and loyalty come close to brands like Apple, Nike, and RedBull. In this regard, consumer retention rates are one of the highest of any car company in the world, ranking highest on J.D Power's 2020 APEAL Study with a score of 896. Furthermore, Elon Musk's leverage saves Tesla billions annually in advertising, as awareness is brought to potential customers through general media coverage.
Musk himself cherishes competition, believing it will only accelerate sustainable transport and contribute to faster innovation. In a tweet, he even offered to license its software and supply batteries & powertrains.
#3: 'Can't be profitable'
In Tesla's latest Q4, bears argued that Tesla actually did not turn a profit if it wasn't for ZEV credits. Tesla earned over $1.5 billion in 2020 from selling zero-emission-vehicle credits, which legacy automakers purchase to compensate for emission mandates. While Tesla earned $270 million in GAAP income in Q4 (+157% YOY), it also earned $404 million in regulatory credits, up by 202% YOY. Gross margins for regulatory credits are significantly higher than pure automotive margins, yet Tesla still includes them in its automative revenue and margins. The credits, therefore, add to Tesla's margins and most importantly, to profitability.
Source: Author
When comparing net income figures with regulatory credits, it's easy to conclude that Tesla wouldn't have been profitable over the last quarter without ZEV credits. Even in the short-term, this argument is far-fetched and even more so in the long term. Tesla has been on the brink of profitability for years, which is the usual case for high-growth companies that reinvest profits into expansion. The point is that EV credits happen to give the impression of being the only reason for Tesla's profitability, which isn't necessarily true. The most important figure to measure Tesla's overall profitability remains free cash flow, standing at $1.8 billion in Q4. That figure increased by nearly 800 million from a year ago, while EV credits only increased by 268 million. Therefore, Tesla's free cash flow in Q4 would still be roughly $1.4 billion if credits were deducted.
Regardless of what perspective, EV credits and subsidies still earn cash for Tesla, which can't be denied. As mentioned before, total regulatory credits for the year were up a staggering 166% from 2019 to $1.58 billion. IMO, this should be interpreted rather positively, as it adds to Tesla's overall profitability. If current growth rates in the credit segment continue, Tesla could bring billions in annual credit revenue as more countries introduce emission trading programs. Of course, the argument is that eventually, large automakers such as GM, Ford, Volkswagen, and Daimler will switch to EVs, with fewer automakers having to purchase regulatory credits from Tesla. However, at that point credit sales will be just a fraction of Tesla's total revenue and proportionally irrelevant.
Similar to regulatory credits, Tesla has been granted billions in subsidies, including tax breaks and federal loans. Bears have mentioned that Tesla couldn't achieve structural profitability without subsidies to fund its rapid expansion. As of mid-2020, Tesla's total subsidies amounted to $2.44 billion, including 82 federal grants and tax credits, as well as 27 state awards. Similar to regulatory credits, it won't change Tesla's narrative in the long-term even if subsidies eventually begin to fade. Regardless, subsidies aren't a bad thing, as the governments demonstrate incentives to support Tesla's mission to accelerate sustainable energy. Moreover, it's been reported that Tesla will be granted at least 1 billion euros ($1.2 billion) in public subsidies to continue developing its battery cells.
#4: 'It's a bubble'
This one is much harder to break down, because frankly, Tesla is overvalued. While an outlandish P/E of 2200 can be vaguely supported by strong earnings growth in coming years and the notion that Tesla will eventually grow into a more reasonable P/E similar to Amazon, it is still overvalued on all other metrics as well. That said, Tesla is trading at over 30x price to sales, much higher than most anticipated technology companies, not to mention car manufacturers.
However, avoiding or even shorting the stock simply on a valuation basis may be too narrow-minded for a company dominating a multi-trillion mega-trend of mobility-as-a-service. Therefore, it is important to add all of Tesla's potential profit drivers in the future to support the sky-high valuation.
Source: Author *based on median estimates (growth)
Revenue is expected to grow to $120 billion by 2025, with net income reaching $17 billion, representing profit margins of roughly 14%. That said, Tesla is trading at roughly 10x EV to sales for FY 2023 and an implied P/E of around 100x. While that still points at dramatic overvaluation, Amazon P/E hovers around 80 in comparison. However, Tesla's 20% gross margins represent rather a typical automaker than a diversified technology company like Amazon. While that's true for now, Tesla's gross margins should increase to 25% by 2024, considering robust scalability. Note that the above estimates don't include a scenario of generating autonomous software revenue and/or an autonomous taxi network.
Our target price is based on the average of 50x our 2025 EPS (discounted back) and EV/sales multiple of 17.5x 2022 (vs. prior 12x) as we believe investor enthusiasm for high-quality pure EV plays and expected confirmation of ongoing technology lead by Tesla should continue to support higher valuation. - Deutsche Bank Analysts
Moreover, general behavioral and demographic finance shouldn't be neglected, with retail investors on the rise. According to research, retail traders already account for 20% of all stock-market activity, as commission-free trading apps make stocks widely accessible. Tesla is among the most bought stocks among Millenials, a demographic set to expand by 3-4 billion people within the next 20 years. In this context, the term 'sustainable investing', otherwise known as ESG investing (environmental, social and governance), is of significant importance, accounting for $30 trillion in assets under management as of 2018 with double-digit annual growth rates.
Source: Author *based on median estimates (considering all gigas will start production as planned)
Explosive sales growth will be in accordance with strong growth in annual deliveries, as seen in the chart above. In Q4, Tesla guided 50% multi-year growth in annual deliveries, likely exceeding the target in 2021. Thus, deliveries for 2021 might be in the range of 850.000 to 900.000 and achieving the milestone of 1 million deliveries in 2022, as production of Model Y is ramped. Cybertruck and Semi deliveries should start as early as 2022, once the Gigafactory in Austin opens up. Moreover, Tesla's sports car 'Roadster' is expected to start its deliveries by 2022, and rumors stating a Model 2 will be unveiled in 2021.
The Tesla Flywheel
As Tesla is beginning to scale effectively, gross margins could exceed 35% on the EV side of Tesla alone. While pure automotive profits will be highly impressive, they certainly aren't sufficient to justify Tesla's current valuation. Thus, investors are betting on Tesla's autonomous flywheel as a future profit driver.
Source: ZDNet (ARK Invest)
Tesla currently offers its FSD software for a $10 thousand one time purchase option. It also announced plans to offer FSD as a subscription option, starting from only $100, which could significantly increase wide adoption of the software. Recurring revenue from FSD could generate incremental >90% margins, dragging up Tesla's overall margins towards 40% by 2025. It's crucial to point out that a $100 monthly subscription is still low compared to the attributed benefits, leaving immense upside for potential price hikes. Even at $100, Tesla would generate some $6 billion in annual recurring software revenue. Moreover, Tesla announced it would be open to licensing its autonomous software to other automakers, which could result in billions of recurring revenue through multi-year contracts. The flywheel in the making could be similar to Amazon, which has diversified its revenue streams into different high-margin segments.
The second exciting opportunity from FSD is a potential autonomous taxi network, which could replace traditional ride-sharing taxi networks such as Uber and Lyft. In a report, ARK Invest has estimated the autonomous ride-sharing market to be valued at over $10 trillion in 2030 and a few trillion today if it were to exist. Autonomous taxis would cut average prices per mile in half, costing consumers just $0.35 per mile with accident rates declining by up to 80%. With a full-on operating autonomous taxi-network, Tesla could generate up to $350 billion, with gross margins exceeding 50%. In comparison to Uber and Lyft, Tesla would be able to charge a significantly higher cut due to eliminating administrative costs. While this may only be speculation for now, the company has already applied for regulatory approval. Again, competitors might follow, but Tesla is years ahead in rolling out an autonomous taxi-network. Tesla also has plenty of opportunities to monetize its gigantic supercharging-network by eventually allowing other EV's to charge, which could bring in additional billions in high-margin revenue.
Concluding remarks
While there's no question that Tesla is currently overvalued, that alone shouldn't serve as a reason to avoid the stock. While Q4 was slightly disappointing to investors, 2021 should be an exciting year as Tesla is coming closer to full autonomy and is set to begin production in Europe. The company already overcame its liquidity issues in recent years, now having some $20 billion in cash and equivalents. As more automakers are increasingly adopting EV models, Tesla's relative market share should drop, yet that should not be a source of concern. Tesla has now fully demonstrated its ability to be profitable, generating $1.8 billion in quarterly cash flow.
Moreover, the ability to generate high-margin revenue from autonomous opportunities should support the given valuation, considering that it could be one of the most profitable companies by 2030 if Tesla executes on FSD as planned. The company continues to surprise, unveiling new models and expansion plans with a charismatic CEO that has built multiple successful companies in his lifetime and holds a powerful vision of the future.