In June, Musk announce plans for Tesla to acquire SolarCity (the solar panel company run by his cousins), which was met with much scrutiny by investors. This was soon overshadowed by the disclosure of a traffic fatality related to the Autopilot feature in Tesla’s Model S sedan. Regulators are investigating the crash and some people think that the company should scrap its Autopilot plans or at least market the dangers of using it.
Wait – why am I talking about Elon Musk right now? Isn’t this website supposed to be about value investing?
Let me explain.
When you think of value investors, I’m pretty sure that Elon Musk is not the first person that pops into your head. He’s probably the poster boy for Silicon Valley start-ups right now, having founded four different billion dollar companies (PayPal, SpaceX, Tesla, and SolarCity). On top of that, Elon Musk may be the most risk-loving businessperson to have ever lived, with his companies disrupting very large, very established industries.
I recently read a new biography on Elon called Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future by Ashlee Vance and – although they are incredibly different in so many ways – I could help but realize that there were some pretty suprising similarities between him and the world’s most famous value investor, Warren Buffett.
For example, Warren Buffett and Elon Musk…
Both Are Committed to Non-Carbon, Clean Energy Solutions
Both Elon Musk and Warren Buffett are behind two companies that are making very big pushes into carbon-free electricity. Musk is chairman and the largest shareholder of SolarCity, a company founded by his cousins Peter and Lyndon Rive in 2006. SolarCity designs, finances, and installs solar power systems and is the country’s leading full-service solar provider.
Elon Musk now wants Tesla to buy SolarCity, allowing the combined company to offer a one-stop battery-and-solar panel solution to consumers.
Meanwhile, Warren Buffett’s company Berkshire Hathaway owns Berkshire Hathaway Energy, which is one of America’s largest energy companies. Many people don’t realize that Berkshire Hathaway Energy is a leader in the renewable energy space – the company is the largest provider of wind power in the U.S. and owns 7% of the country’s total wind generation capacity and 6% of the U.S. solar market. In fact, a third of Berkshire Hathaway Energy’s power comes from renewable and non-carbon sources.
However, just because the two billionaires see renewable energy as the way of the future, it doesn’t mean they are exactly on the same page. There’s actually been an ongoing disagreement between the two in Nevada, where Buffett is trying to prevent SolarCity’s solar panel customers from being able to sell their excess energy back to the grid (a process called “net metering”). Because Berkshire is forced to buy back the excess energy at a higher price than it would cost the company if it produced the energy itself, Buffett says that Berkshire’s million+ non-solar customers in the state are effectively subsidizing SolarCity’s 17,000 solar panel customers, which he doesn’t think is fair.
Both Take Advantage of Inventive, Cheap Sources of Funding
Many people know that Buffett generally despises leverage (the use of debt to juice equity returns). And throughout his career, Buffett has maintained a conservative balance sheet, preferring to hold large amounts of cash rather than take on massive amounts of debt. However, many people may not know that the Berkshire Hathaway empire was basically built on a very peculiar source of financing: insurance float.
Here is Buffett’s explanation of what float is from the 2009 Berkshire Hathaway annual letter:
Insurers receive premiums upfront and pay claims later. […] This collect-now, pay-later model leaves us holding large sums — money we call “float” — that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. […]
If premiums exceed the total of expenses and eventual losses, we register an underwriting profit that adds to the investment income produced from the float. This combination allows us to enjoy the use of free money — and, better yet, get paid for holding it. Alas, the hope of this happy result attracts intense competition, so vigorous in most years as to cause the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Usually this cost is fairly low, but in some catastrophe-ridden years the cost from underwriting losses more than eats up the income derived from use of float. […]
Our float has grown from $16 million in 1967, when we entered the business, to $62 billion at the end of 2009. Moreover, we have now operated at an underwriting profit for seven consecutive years. I believe it likely that we will continue to underwrite profitably in most — though certainly not all — future years. If we do so, our float will be cost-free, much as if someone deposited $62 billion with us that we could invest for our own benefit without the payment of interest.
Let me emphasize again that cost-free float is not a result to be expected for the P/C industry as a whole: In most years, premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall return on tangible equity has for many decades fallen far short of that achieved by the S&P 500. Outstanding economics exist at Berkshire only because we have some outstanding managers running some unusual businesses.
In other words, Berkshire’s insurance operations take in premiums from customers today and, because they don’t have to pay claims until years in the future, the company is able to invest those premiums immediately and start earning a return. This difference between the the amount of premiums collected and the amount of claims paid out is called “float”. Float is like a loan, since the insurance company is borrowing from its customers today (premiums) and must pay them back in the future (claims).
The ability to invest float is so valuable that most insurers will actually operate at an underwriting loss (i.e. the cost to obtain premiums and the amount of claims paid out today exceeds the amount of premiums taken in) just so they can get their hands on this float. Berkshire’s insurance companies are run so well, however, that the company usually operates with an underwriting profit – so the cost of float to Berkshire is $0! This is truly ingenious! In 2015, Berkshire had $88 billion in float… which is like having an $88 billion 0% interest loan.
Elon Musk, on the other hand, has nothing to do with the insurance industry so his companies don’t use float – but I’ve noticed that he also has a very clever financing trick of his own: customer deposits.
Customers that want to buy a Tesla car must put down a $1,000 deposit. When Tesla unveiled its next car, the Model 3, in April 2016, it got 373,000 pre-orders within a month. This equates