I want to harp on an idea central to many of my posts here: a share of stock isn’t just a ticker but a piece of a business. That business isn’t as simple as it may appear. Private prisons are a way to skirt public unions; RetailMeNot is a play on Google’s search engine results. Who would have thought?
The face of a business is a façade – the financials reveal the intricacies.
Tesla (TSLA) looks simple by automotive standards. It doesn’t employ union workers, so there’s no pension accounting. It doesn’t have a towering finance arm on the balance sheet, so there’s no need to find a comparable finance institution for valuation.
Unlike many automakers, though, Tesla stock is increasingly hinged on a few variables that have little to do with the automotive business at all. These variables are improvements in battery technology, and the resale valuation of its cars.
- On Battery Technology – As it exists today, Tesla’s business and valuation require substantial increases in battery technology and rapidly declining battery costs. Sell-side analysts have said that virtually all of value in their price targets come from the 3rd generation Tesla which CEO Elon Musk believes can be sold at the low, low price of $40,000 before tax credits. This barebones Tesla would debut by 2017 at a price just one-third more expensive than the average car in 2013. Battery costs would have to halve and consumers would have to be willing to accept less range between battery charges, perhaps as little as 100 or 120 miles.
- On Resale Prices – It’s not easy to sell a car at a price near the average cost of a midwestern home. Tesla created a new financing program for its existing models to reduce barriers between consumer interest and purchase. That financing program requires Tesla to wager on the resale value of the car by guaranteeing a price equal to 50% of the base model cost plus 43% of the purchase price for extra batteries. The resale value of a used Tesla is contingent on the condition of the battery. As a result, some 30% of all cars sold in the latest quarter were sold as part of the guaranteed resale price financing program. If Tesla misses on the resale value, the balance sheet could take a massive one-time impairment. That risk grows with each Model S on the road, since one major defect can kill the resale value.
Industry insiders seem to think Tesla is overshooting with its goal of a low cost electric automobile. Other automakers forecast 20-30% declines in battery costs by the time Tesla tries a new $40,000 ride. Musk says battery costs will work in their favor to the tune of 50% declines.
Musk needs to be spot on. Lower battery prices make a $40,000 car possible. If prices drop too quickly, used Model S models may sell too cheaply, especially when consumers compare the higher-end, used Model S to a brand new $40,000 car.
Everyday Driver or Hamptons Cruiser?
The only thing keeping a Tesla out of the hands of every driver in the developed world is really the cost, which ultimately comes down to the battery technology. Until Tesla can break into the everyday driver territory of $30,000-$40,000, it remains a rich man’s luxury car.
Yesterday’s earnings report revealed that Tesla is capitalized to see its plans through. Tesla reported $746 million in cash on its balance sheet, which gives it enough funds to work on aggressive plans that include new service centers, charging stations, and battery swapping platforms.
The most optimistic tidbit in the report was news that the company acquired 31 acres of land surrounding its existing factory for future expansion. Keep in mind that the company uses only a fraction of its existing floor plan acquired at bargain bin prices of $42 million in 2010.
An Investment That’s Out of Your Hands
Tesla may be an automaker, but it’s similar to a pharmaceutical company or gold mine – its future relies on something that is virtually impossible to predict. That something (declining battery prices) is just as much of a dart throw as 2017’s hit blood thinner or 2020’s gold prices.
This is one of the rare scenarios where I think it makes sense to wait. At $15 billion, negative earnings, and quarter-to-quarter cash burn above $100 million, Tesla has to grow into its valuation.
As a company, I think it has clear advantages. It has a brand people love to adore, a loud and proud base of owners, and being 100% equity financed with zero union employees, it has one of the cleaner balance sheets in the industry. If Tesla stock shareholders give the company license to lose money to steal share like Amazon investors have given the web-based retailer, its future is very bright.
But at the base, it’s a bet on Musk. If Musk is right about the future of battery prices, Tesla’s an over-valued story stock that will likely grow into its valuation…someday. If he misses, and the $40,000 model is delayed indefinitely, Tesla’s share price will come quickly back down to earth.
If I had to wager, I’d take the S&P 500 over Tesla Motors, even though I’m critical of valuations across the board. Tesla fans are fierce – they don’t play nicely with those who pass on the stock – but the truth is, they have no more insight into the future of battery prices than anyone else in the world. It’s better to be quiet and wrong, than loud about predictions as accurate as predicting next week’s lottery.
What are your thoughts on Tesla’s valuation and future?